Another Benign Inflation Print

There's just no way the Fed will hike with the kind of inflation readings we're getting

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My North Star on inflation is that we’ve had all kinds of supply shocks in recent years - COVID supply chain disruptions, Russia’s invasion of Ukraine and now the war with Iran - yet underlying inflation has stayed well behaved. That to me says the hurdle for inflation to take off is high and - if anything - we should be concerned about building disinflationary pressures coming from AI and all the disruption it’s going to cause to white-collar employment.

Markets take a different view. They went into the July FOMC meeting pricing ten basis points in hikes, quite remarkable given that core inflation for June had fallen sharply just a few weeks earlier. As I noted yesterday, all the recent hand-wringing about inflation strikes me as political. Markets are trying to push Warsh into hiking because they think he’s under orders from the President to cut. As long as markets keep this up, they’ll get right-sized by data and yesterday’s CPI report for July was part of that. Markets revised down the odds they put on a September hike, but they did so grudgingly and continue to price more than a full hike by the end of 2026.

On the surface, yesterday’s CPI wasn’t amazing. The black line shows year-over-year inflation. The blue bars are month-over-month inflation, which I annualize so it’s on the same scale as the year-over-year numbers. You can think of the black line as a 12-month moving average of the blue bars. The only reason the black line fell in July is because the monthly inflation impulse in July 2025 - which dropped out of the year-over-year number - is bigger than the latest impulse. That’s what nerds like me call a “base effect” and is very unexciting.

But there’s much more going on under the hood. The black line in the chart above is month-over-month core inflation, so it’s the same as the blue bars in the chart above (only now there’s no annualizing). Core has lots of noisy stuff in it, so the blue bars are my preferred tracker for what’s really going on. They represent 30 percent of core and are what’s left after you drop owners’ equivalent rent (purple), healthcare (red) and transportation (yellow). This “core of core” was flat in July after being slightly negative in June. There’s a lot more disinflation once you look under the hood, so - in my view - all the hand-wringing about inflation is misplaced.

Which brings us to market pricing. The black line in the chart above is the midpoint of the Fed’s 25 basis point range for the policy rate. The orange line is what markets were pricing into the July meeting. The gray line is what they price for September and the blue line is what’s priced through the end of 2026. Markets yesterday correctly saw the data as dovish and reduced their expectations for hikes. But they did so reluctantly and we’re still pricing 11 and 29 basis points, respectively, for September and through the end of the year. Markets are determined to stick with their hawkish narrative for what the Fed should do, which means “the beatings will continue until morale improves.”