Advisors eye rate odds as July CPI likely keeps Fed on hold — for now

In-line July CPI data pushed the odds of steady rates at the Fed's September meeting above 55%, but with three FOMC members recently pushing for hikes, advisors may want to prepare clients for a livelier-than-usual policy debate this fall.

Data from the U.S. Bureau of Labor Statistics released early Wednesday show that July’s CPI increased 3.4% over the last 12 months, down from 3.5% in June, which saw CPI hit its highest level in three years. July’s CPI number was in line with expectations from economists surveyed by Dow Jones Newswires and The Wall Street Journal.

CPI is an important measure for inflation, and the latest numbers follow a weak jobs report last week that was seen as likely keeping the Fed on hold.

“Inflation is still drifting in the right direction, which is a small relief given the uncertain geopolitical situation,” Nic Puckrin, macro analyst and founder of Coin Bureau, in note Wednesday. “But it’s still well above the Fed’s 2% target, so don’t mistake this glimmer of hope for proof that inflation has been beaten.”

Puckrin warns that if the situation in Iran remains volatile, oil prices won’t be coming down to manageable levels, which makes it very difficult “to tame the inflation genie” without raising rates. 

“The problem is, last week showed that the labour market is cracking,” he added. “That puts the Fed in a difficult bind. It can’t cut to save the jobs market without pouring fuel on the inflation fire, and if it hikes to tame prices it risks pushing the jobs market over the edge.”

These sentiments were echoed by Chris Zaccarelli, chief investment officer for Northlight Asset Management. “The big surprise with a report that had no surprises (all of the data came perfectly in line with the estimates) is that a situation where inflation isn’t reaccelerating, coupled with the most recent, weak jobs report gives the Fed more time to wait,” he said, in a note. “Typically, the market would be buoyed by the thought of rate cuts, but in a world where many are expecting rate hikes, anything that can delay – or squash the need for – rate hikes will be viewed positively.”

On Wednesday morning the CME’s FedWatch tool puts the probability of rates being unchanged at 55.9% for September’s Fed meeting. A hike to between 3.75% and 4% has a likelihood of 44.1%, according to the tool, which updates in real time.

The latest CPI data offered no surprises across the board. On a seasonally adjusted basis, CPI increased 0.1% in July, also in line with expectations, after falling 0.4% in June.

Core CPI, or the index for all items less food and energy, rose 0.2%, in line with economists’ expectations, after being unchanged in June. On a year-over-year basis, core CPI rose 2.5%, also in line with expectations, after rising 2.6% in June.

Last month, in its second meeting with Kevin Warsh as chair, the Fed maintained its strategy of keeping its policy rate steady, although there were three dissenting voices on the Federal Open Market Committee who preferred to raise the target range for the federal funds rate.

“We expect the debate at the September FOMC meeting to be lively as the economy experiences a tight labor market while the inflation picture is quite blurry,” said Jeffrey Roach, chief economist for LPL Financial, in a note. “Our baseline is the Fed holds rates steady, but an increasing number of voting members are hawkish and could convince the majority to implement a hike.”

However, Stephen Coltman, head of macro at 21shares, thinks that the latest CPI data could provide some fuel to FOMC doves.

“This mild inflation report is perhaps not quite enough to put to bed the argument over whether or not to hike in September, but at the margin it further strengthens the dovish case,” he said, in a note. “With the recent run of softer than expected data in the US we have seen a tentative rebound in the so called ‘debasement’ trade, and today’s number will only reinforce that trend of a weaker dollar, a steeper yield curve, and a rally in assets such as gold and bitcoin.”