The inflation report that everyone had been waiting for landed on Wednesday, and it did not cause any drama. The CPI edged up just 0.1% in July, matching forecasts and bringing the annual inflation rate to 3.4%.
Strip out food and energy, which bounce around for reasons that have little to do with the broader economy, and the picture looks even calmer. Core inflation rose 0.2% for the month and sits at 2.5% on an annual basis. That is the same pace we saw before the U.S. and Israel attacked Iran back in late February, which tells you how much the recent spike has faded.
The energy index has dropped 7% from its May peak. If you have filled up a gas tank recently, you probably noticed.
Shelter Costs Are Finally Settling Down
The biggest piece of the inflation puzzle is housing. Shelter costs make up roughly one-third of the CPI basket, so when they move, the whole index feels it. For the last two months, they have barely budged, rising just 0.1% each month.
Dig a little deeper and the trend gets even more interesting. The "lodging away from home" category, which covers hotel and motel prices, has fallen sharply during three of the last four months. Meanwhile, owners' equivalent rent, which is how the government measures what homeowners would pay to rent their own properties, stayed roughly flat over that same stretch.
This matters because housing was the main reason inflation stayed stubbornly high for so long. With that pressure easing, the path forward looks smoother.
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What This Means for the Fed
The Federal Reserve has been wrestling with whether to raise interest rates again at its September 15-16 meeting. Rate hikes are the Fed's main tool for cooling inflation, but they also make borrowing more expensive for everyone else.
As of late Wednesday morning, the markets put the odds of a September hike at just 38%. In other words, the conversation has shifted from "when will they hike" to "will they hike at all."
Dan North, senior economist at Allianz Trade North America, put it simply: "This makes life for the Fed a little bit easier because now there's less pressure for that hike that everybody was expecting. Inflation appears to be getting tamer."
Bank of America economist Stephen Juneau is sticking with a forecast for 75 basis points of increases this year, starting in September. But he admits the recent run of calm inflation data has increased the chances that hikes get delayed or never happen at all.
The Catch Hiding in the Data
Before anyone declares victory, there is a wrinkle. Crude oil prices jumped 10% over the past week. That spike happened after the July data was collected, which means it will show up in the August inflation reading instead.
Oil is one of those costs that touches everything. When crude goes up, gasoline follows, and so do shipping costs, which eventually show up in the price of just about everything you buy. One calm month does not erase that risk.
TIAA Wealth Management's chief investment officer, Niladri "Neel" Mukherjee, said Wednesday's report matched expectations, prompting traders to reduce the probability of a September rate increase. But he said it is unlikely to change many voters' minds on the committee, since there are elements in the data that support both sides of the argument.
The Bottom Line
For your portfolio, the takeaway is fairly straightforward. The odds of another rate hike have fallen sharply, which is generally good news for stocks and bonds. But oil prices are a wild card, and the Fed is still data-dependent.
If August inflation comes in hot, the conversation could flip again. For now, the pressure has eased, and the markets are breathing a little easier.
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