A report issued by the U.S. Bureau of Labor Statistics on August 14, 2024, showed that the U.S. consumer price index (CPI) rose at a rate of 0.15% in July, while the core rate, which excludes food and energy prices, rose 0.17%. The monthly increase in the core CPI was below the pace consistent with the U.S. Federal Reserve’s (Fed) 2% inflation target for the third month running.

The data clear the way for the Federal Open Market Committee (FOMC), the Fed’s policy-setting arm, to cut rates in September, even if the details of the inflation report weren’t quite as favorable as the headline. A 25-basis point (bp) reduction seems more likely than a 50-bp cut since the Fed is fine-tuning the level of rates as opposed to acting to ease tight financial conditions. If economic activity deteriorated suddenly, the FOMC would act to provide stimulus by implementing larger rate cuts.

Since the last three months of good results for core inflation come after a long string of price increases that were well above the pace consistent with the inflation target, longer-term inflation remains too high. For example, core inflation rose at a 3.6% annual rate over the past six months and 3.2% year-over-year. That matters because in the short term, technical factors such as seasonal adjustment exert a large influence, while the impact is neutralized over a 12-month period.

Other things equal, the FOMC would prefer to wait for assurance that the past three months of favorable results weren’t another “head fake,” but in the present circumstances—with short-term rates 250 bps over the neutral rate—the committee feels it has latitude to implement rate cuts for insurance purposes so long as inflation is trending toward the target, however gradually, rather than settling in above it.

Some additional observations on the July CPI report:

  • After very low rent inflation in June, increases for both tenants’ and owner-equivalent rents rose more rapidly in July. Rent inflation is quite sticky, and the sharp deceleration in June looked suspect. Monthly rent inflation is still rising at almost twice the pace as in the business cycle before the pandemic. Very low vacancy rates and declining completions of multi-family dwellings suggest it will continue to exert upward pressure.
  • Core consumer commodity prices continue to fall at a notable clip. Sharply lower used car prices provide most of the explanation for that behavior. Inasmuch as the price of used vehicles relative to new ones has fallen sharply enough to approach the pre-pandemic trend, it seems likely they will decline at an attenuated pace in coming months.
  • “Supercore” inflation—core services excluding rents—has also been very well behaved over the past three months. Extending the window to six- and 12-month periods changes the picture considerably, however, with price increases running at 5.3% and 4.4%, respectively. Inflation in some of the stickier components of the supercore CPI—food away from home and personal care services, which are thought to exhibit a fluid passthrough from costs to prices, are showing signs of bottoming out at paces well above pre-pandemic norms.

Policy & Investment Implications

The “sticky” components of inflation are still rising too rapidly to feel comfortable that a return to 2% inflation in the medium term is assured. But the FOMC appears eager to preserve easy financial conditions and a 25-bp rate cut at the September meeting seems highly likely. But based on trading in fed funds futures, the market is priced for something much more aggressive—175-200 bps over the next 12 months—and that is unlikely unless the economy slows sharply.

Against this backdrop, we believe an emphasis on shorter-maturity investments may be appropriate. Credit may also be an attractive choice, as investors can still realize attractive positive carry above U.S. Treasury yields. Modestly above-trend inflation has historically been supportive of corporate credit quality and a below-average default experience.

Among equities, we favor companies in the innovation space, along with stocks of quality companies—those with steady, consistent revenue growth. We continue to see opportunity in international equity markets, which remain attractively valued relative to the United States.