US CPI recap: A turning point in the inflation debate?

In Monday’s CPI preview report, we noted that traders and economists were looking for a decline in headline inflation in July, based heavily on base effects and falling gasoline prices, but the so-called “core” CPI reading (stripping out food and energy prices) was still expected to rise.

As it turns out, the just-released CPI report showed inflation declining at an even faster rate than economists were expecting:

• Headline CPI printed at 0.0% m/m, 8.5% y/y
• Core CPI came in at 0.3% m/m, 5.9% y/y

Looking into the individual components, the cooler-than-expected CPI report was driven by sharp declines in energy (-4.6%), gasoline (-7.7%), and used vehicle (-0.4%) prices, whereas the components showing rising prices, like housing / “owners’ equivalent rent” (+0.6%), did not see a meaningful acceleration. Notably, this was the first headline CPI reading that came in below expectation in 11 months!

Market reaction

With so much riding on inflation readings, markets have justifiably seen a big reaction to this morning’s surprisingly soft reading. Crucially, the market-implied odds of a 75bps interest rate hike from the Fed at its next meeting have fallen from nearly 70% before the release to just 25% now, according to the CME’s FedWatch tool. While we still have another NFP and CPI report before the Fed’s next monetary policy meeting, the combination of strong jobs growth and falling inflation that we’ve seen over the last week will certainly have Jerome Powell and company breathing a bit easier.

Not surprisingly, the US dollar has come under strong selling pressure in the wake of the report, with the greenback dropping by roughly 100 pips against all of her major rivals. As the below chart shows, the US dollar index is poised to close below its 50-day exponential moving average for only the second time since February. A close near current levels could set the stage for a deeper pullback toward the 100-day EMA near103.75 next:

Source: StoneX, TradingView

Elsewhere, we’ve seen US equity indices catch a big bid on hopes of less aggressive interest rate hikes, while commodities like gold and oil have rallied on the back of the drop in the world’s reserve currency.

If the “peak inflation” theme gathers steam in the coming weeks, we may look back at today’s inflation reading as a major turning point for the year-to-date market trends.

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