Has Inflation Peaked?

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This article was authored by: Lawrence Fuller

The Consumer Price Index (CPI) fell on a monthly basis for the first time in six years, reversing the surge in gasoline prices that struck after the war started in March. The 0.4% decline was better than the 0.2% drop expected, leading the annualized rate to fall from 4.2% to 3.5%. The core rate, which excludes food and energy, saw no change for the month, which was also better than the 0.2% increase expected. That resulted in the annualized rate falling from 2.9% to 2.6%. This was particularly important because it reversed three consecutive months of increases in the core rate, which should alleviate concerns that price pressures from the war are broadening out. In addition to the near 10% plunge in fuel costs, within the core rate, there was a decline in prices for used cars and trucks, apparel, and medical care. Services prices were flat, with shelter costs up just 0.1%. It looks like we are seeing very little pass-through at this stage from war-related energy costs and tariffs, as well as the AI capital investment cycles. These are primary concerns for the Fed today. This decline in the rate of inflation for June restored real wage growth, which advanced 0.8% from May to June, resulting in a 0.3% increase in real (inflation-adjusted) weekly take-home over the prior year. That doesn’t sound like much, but it is much better than the declines we saw in the prior three months. Real income growth is the ultimate fuel for consumer spending power. Progress on the inflation front led to a sharp decline in Treasury yields, with the 2-year plunging more than ten basis points to 4.19%. This report takes pressure off the Fed to hike short-term rates at its July meeting, which the consensus of investors saw as better than a 50% probability. It also reduced the likelihood of a rate hike in September, with that probability falling from 75% to 58%. As I have said repeatedly since Kevin Warsh was appointed Chairman, the Fed is not going to raise interest rates this year. This is a misplaced concern by investors who are focusing on lagging indicators and the rhetoric coming from Fed officials (including Warsh) who want to control inflation expectations. We may give back some progress on inflation next month if the escalation in Iran gets worse. The current price of oil, as well as prevailing yields, is likely to give Trump second thoughts about pursuing more aggressive tactics in the Middle East. He wants both to be significantly lower in advance of the midterms.