The U.S. Bureau of Labor Statistics will release the July Consumer Price Index (CPI) on Wednesday at 8:30 a.m. Eastern Time (8:30 p.m. Beijing time on Wednesday). The Dow Jones consensus forecast suggests that headline CPI is expected to rise 0.1% month-over-month, while core CPI, which excludes food and energy, is forecast to increase 0.2%. On an annual basis, headline and core CPI are expected to rise 3.4% and 2.5%, respectively, each down 0.1 percentage point from June. Even so, the annual inflation rate remains well above the Federal Reserve's 2% target. If the July data meets expectations, two consecutive months of relatively tame inflation readings would provide the Federal Open Market Committee (FOMC) with more time to assess the situation.
"If the July CPI report we get is roughly in line with my forecast, the committee's overall stance will be to look straight through the supply-side shock effects, and the FOMC will stay on hold for the remainder of this year," said Joe Brusuelas, chief economist at RSM. He believes the data would also provide "some help" for Fed Chair Powell, who has faced a complex policy environment since taking office in May.
A Decision Point Approaches
At the July meeting, the FOMC voted 9-3 to keep the key lending rate at 3.5% to 3.75%. The three dissenting members all supported a 25-basis-point rate hike. Governor Lisa Cook recently indicated that if inflation data does not cooperate, she believes a rate hike may be necessary. A combination of weaker economic data in recent weeks and recurring signs of easing in the Middle East situation has already prompted the market to readjust its interest rate expectations. The CME FedWatch tool shows that traders currently see a roughly 50% probability of a rate hike in September, while the chances of a move in October or December are relatively higher. Before the Fed's next policy meeting, it will receive two more months of inflation data for July and August. Since the Kansas City Fed will hold its annual symposium in Jackson Hole, Wyoming in August, the Fed will not hold a regular policy meeting that month.
"If you're not confused, you haven't been paying attention," Brusuelas said, adding that this statement aptly describes the policy environment the Fed faces in mid-August. Inflation showed a clear easing in June, when headline CPI fell 0.4% month-over-month and core CPI was flat, driven by lower energy prices and moderating housing costs. The labor market is also flashing potential signs of weakness. Data released last Friday showed that the U.S. economy lost 23,000 jobs in July, while the unemployment rate fell to 4.1%.
Dennis Follmer of Montis Financial said, "I expect the CPI to continue its downward trend, which would further support the Fed in keeping rates steady rather than hiking, despite the weak employment report last Friday." However, some economists still worry that the July CPI could surprise to the upside, or at least show that inflation remains too stubborn for the Fed to ignore. Bank of America even still expects three rate hikes in the coming months. In a note to clients, the bank's economists said the July employment report "did not change the overall picture of the labor market—the market is still stable." The report argued that, more importantly, recent comments from Fed officials indicate the Fed's policy reaction function has largely shifted to focus on inflation data. Bank of America expects that if the Fed's preferred inflation gauge averages a 0.25% increase over the next two months, "it is almost certain the Fed will begin raising rates in September." If the average increase is below 0.2%, a rate hike could be delayed, while a reading between 0.2% and 0.25% would make the September decision a "coin toss." The final outcome will depend on Powell's policy leaning and whether the market's judgment from recent reports—that he is truly willing to hike if necessary, or if the dovish stance shown at the July press conference better represents his policy reaction function—holds true.
An Inflation Surprise Could Open the Door to a Series of Hikes
If inflation significantly exceeds expectations in July, the risk Powell faces may not be limited to just one rate hike. The Fed typically does not make only a single adjustment in one direction. Cleveland Fed President Beth Hammack is one of the more clearly hawkish voices. She was one of the three dissenters at the June meeting and said on Monday that the Fed may need to raise rates multiple times. "I'm not sure where we'll end up. Generally, a single 25-basis-point move probably won't have a huge impact on the economy. So, it may take a certain number of adjustments, but I don't want to prejudge the exact number," Hammack said in an interview with Yahoo Finance. She emphasized, "Because we have this stability in the labor market, I am fully focused on getting inflation back to our target level."
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