US Annual Inflation Turns Higher in the Dog Days of Summer

Some market observers were stumped when Federal Reserve Chair Jerome Powell suggested that the annual inflation rate would not return to the central bank's 2% target for another few years. Why, the consumer price index (CPI) had been slowing for 12 straight months after hitting the 9.1% peak in June 2022. Bidenomics achieved this victory! Not so fast. With the latest CPI print rising for the first time in a year, should the US economy brace for renewed across-the-board price pressures?

The July Inflation Report

According to the Bureau of Labor Statistics (BLS), the annual inflation rate rose to 3.2% in July, up from 3% in June and slightly lower than the consensus estimate of 3.3%. The core CPI, eliminating the volatile food and energy components, slowed to 4.7%, down from 4.8% and below the market forecast of 4.8%. Both CPIs climbed 0.2% on a month-over-month basis. Here is a month-over-month breakdown of the CPI categories last month:

• Food: +0.2%

• Energy: +0.1%

• New Vehicles: -0.1%

• Used Cars and Trucks: -1.3%

• Apparel: 0%

• Medical Care Commodities: +0.5%

• Shelter: +0.4%

• Transportation Services: +0.3%

• Medical Care Services: -0.4%

But while these headline numbers might not be much to spark economic outrage, the figures underneath the surface may lead to frustration. For example, classical kitchen staples rose at considerable paces from June to July, such as bread (+0.9%), rice (+0.9%), beef and veal (+2.4%), oranges (+1.6%), coffee (+1.3%), and butter (+0.7%). Or on the energy front, fuel oil surged 3%, gasoline edged up 0.2%, and natural gas services jumped 2%.

Crude oil could play an integral role in the near-term trend for inflation. Since plunging to $67 at the end of June, West Texas Intermediate (WTI) prices have soared to as high as $84 per barrel, a fresh 2023 high on the New York Mercantile Exchange. This has resulted in more pain at the pump, with the national average price for a gallon of gasoline at $3.83, up 20% year-to-date.

Services inflation, which represents nearly half of the monthly CPI report and is something the Eccles Building pays close attention to, eased to an annualized rate of 5.7% in July, down from 5.74% in the previous year. This was the lowest reading in more than a year.

Shelter remained stubbornly high in July, as the index picked up another 0.4%. The rent of primary residence within the category also increased by 0.4% and is up 8% year-over-year. It is worth noting that shelter is a lagging indicator, prompting the chattering class – and Chair Jerome Powell – to argue for nearly a year that rents are coming down. Still, renters have yet to see this expectation come to fruition.

Looking ahead to the August CPI, the Federal Reserve Bank of Cleveland’s Inflation Nowcasting model estimates that the year-over-year inflation rate could touch the 4% mark again.

The Reaction

Indeed, the inflation numbers from the BLS offered different reactions.

The White House purported that the latest CPI data show a strong economy. "Today’s numbers show our economy remains strong. Annual inflation has fallen by around two-thirds since last summer, and real wages are up for working folks this year. We've done this while maintaining near-record-low unemployment and strong economic growth. That's Bidenomics," the administration said in a statement.

US financial markets ostensibly yawned at the news. At first, the leading benchmark indexes, like the Dow Jones Industrial Average and the Nasdaq Composite Index, popped at the softer-than-expected inflation figures. But they eventually ended the Aug. 10 trading session relatively flat. Traders were weighing how the July CPI report could impact the Federal Reserve’s September policy rate decision. Meanwhile, central bank officials remarked following the inflation data that there is more work to do.

The reality? Inflation might persist and be above-trend for many years to come. Investors tend to believe the same thing as market-implied inflation expectations for the next ten years have climbed to the highest levels in more than a year. In other words, it might be time to prepare for a climate of high inflation and elevated interest rates. It is time to party like it is the 1990s all over again.