- Goods prices are still largely well-behaved.
- Services are showing signs of firming.
- We are sure there is more tariff-related inflation in the pipeline.
- Still, the Fed would shift focus toward weakening demand, providing rationale for rate cuts.
- We are looking at two 25bps cuts before the year is over.
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July CPI print (headline: 2.7%yoy, core: 3%yoy) was in line with expectations. The data offer a mixed picture—goods prices were broadly well-behaved, with tariff-relevant categories like toys and furniture yet to show any spikes, but services prices were on the strong side, with airfares, medical care, and recreation picking up pace. There was a rebound in used-auto prices as well. Inflation momentum, measured as the 3-month/3-month rate, annualised, picked up.
If the Fed officials remain focused on inflation, they will find areas to worry about. On tariffs, the playbook is clear; US firms are (i) squeezing suppliers, (ii) taking a hit on their balance sheet, and (iii) passing on parts of the tariff to consumers. (i) and (ii) are most visible now, and (iii) is also materialising, in a protracted manner.
There are other risks to inflation, ranging from a weaker dollar to an apparent bottom in energy prices. Additionally, the ongoing crackdown on undocumented workers is creating a supply crunch in agriculture, fisheries, construction, and recreation. This could feed into higher wage costs first and higher prices shortly thereafter.
But Fed officials may be shifting their focus. Looking at the jobs market, where the goods sector looks lacklustre, and overall hiring appears to be propped up, temporarily, by the public sector, there are several pockets of concern. Combine this with weak PMI readings and a loss of momentum in retail sales, the Fed may be heading toward focusing on the demand side of the economy, which would push it toward cutting rates. We are looking at two 25bps cuts before the year is over.
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