US CPI for July shows first signs of inflation peaking

• July headline CPI stays at 5.4%, core slips to 4.3%, about as forecast.
• Dollar weakens, Treasury yields are mixed, as the case for rate hikes diminishes.
• Used-car prices rise 0.2% in July after June’s 10% increase.

American consumer prices delivered the first hint that the rampant gains since January may have reached their apogee, lending support to the Federal Reserve claim that inflation increases will be transitory.

The Consumer Price Index (CPI) rose 0.5% as forecast in July, down from 0.9% in June. The annual rate was unchanged at 5.4%, matching the largest increase since August 2008, reported the Labor Department in Washington, D.C.  It had been predicted to drop to 5.3%. 

Core prices, which exclude volatile energy and food costs, climbed 0.3% on the month, also down from 0.9% in June and lower than the 0.4% projection. The yearly rate was 4.3% in July, as expected by analysts, from 4.5% prior. 

Prices have been on a tear this year as the economy reopened and consumer demand, supply chain disruptions and labor shortages combined with the reversal of last year's lockdown collapse, drove inflation gains to their highest in over a decade. 

CPI                                                                                                                                

Core CPI

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Yearly inflation more than tripled from 1.4% in January to 5.4% in June and July and the core rate soared from 1.4% at the beginning of the year to 4.5% in June and 4.3% in July. 

Federal Reserve policy

The Federal Open Market Committee (FOMC) has kept the fed funds rate near zero for the past 18 months and maintained short-term yields at record lows with $120 billion a month in purchases of Treasuries and mortgage-back securities. 

The Federal Reserve has maintained for almost  a year, since adopting inflation-averaging as its policy diagnosis last September, that the outsize price jumps will diminish and halt as the disparity from the lockdowns dissipates. 

Treasury yields and the dollar had been on the rise since last week when comments from several Fed officials, including Vice-Chair Richard Clarida, and the stronger than expected Nonfarm Payrolls report on Friday, made it seem that the  labor market conditions for a reduction in the bank’s bond purchases might be nearing. 

Central bank officials have given no timeline for the projected policy reversion but the June Projection Materials which compiles Fed estimates, raised the annual Personal Consumption Expenditures Price Index (PCE) forecast for 2021 to 3.4% from 2.4% and the core rate to 3.0% from 2.2%. 

The PCE averages through June were 2.8% and 2.5% for core. These rates will rise as the year extends with much higher numbers in the final two quarters.   

Core PCE

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July’s PCE figures will be reported by the Bureau of Economic Analysis on August 27. 

Market response

The dollar faded as the CPI report was released, losing about 30 points versus the Japanese yen, the euro and  the sterling, falling versus the rest of the majors and maintaining those reverses into the early afternoon. 

Equities rose with the Dow up 195.15 points, 0.55% to  35,458.82 at 121:56 pm, a new 52-week high. The S&P 500 had added 5.60 points to 4,442.35, also a new annual high. 

Dow                                                                                                                           

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S&P 500

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Treasury yields moderated their increases of the last few days, with the 10-year losing 1 basis point to 1.33% and the 30-year increasing 1 point to 1.994%.

GDP and consumer spending

The US economy expanded at a 6.5% annual rate in the second quarter following the 6.3% pace in the first three months of the year. 

Consumer spending rose 11.8% in the second quarter, as the vaccination program ended lockdowns and American responded with a burst of purchases, travel and activities from vacations to dining out. 

Used car and truck prices, which rose rapidly in the first half of the year as new cars became scarce due manufacturing delays caused by computer chip shortages, moderated in July adding just 0.2%, after jumping 10% in June. 

Clothing prices were unchanged following June’s 0.7% gain. The cost of transportation services dropped slightly after rising more than 1% inJune. 

Conclusion

The slight moderation of CPI in July has not changed the economic background  that will maintain much higher levels of inflation in the second half of the year. 

Labor shortages, rising energy costs and widespread component and supply chain scaricities, will  keep the pressure on businesses to maintain profit margins. 

For instance, the leisure and hospitality sector, the hardest hit in the job losses of last year, still has more than 1.6 million openings. 

Employers have been forced to raise pay or offer signing bonuses as the Labor Department reported 10.07 million unfilled positions in June, the highest on record for the Job Openings and Labour Turnover survey (JOLTS). 

JOLTS

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Firms have shown an ability and a willingness to pass some of these costs on to consumers instead of absorbing  them as they have over the past decade. 

If the July NFP report which is due September 3, provides another healthy dose of job creation, the Fed may be hard-pressed not to announce a policy shift at the September 21-22 FOMC meeting, regardless of the intervening inflation development.