CPI Cools Modestly; How Will the Fed Play This?

As expected, the Consumer Price index cooled a bit thanks to falling gasoline prices. The question is will this give the Federal Reserve the excuse it needs bow out of the inflation fight?

The Consumer Price Index for July was up 8.5% year-on-year. That was down from June’s 9.1% print and slightly below the 8.7% expectation. Of course, an 8.5% increase in prices over the course of a year is still extremely hot.

Month-on-month, CPI remained unchanged.

Core CPI excluding more volatile food and energy prices rose by 0.3% from June to July, but held steady at 5.9% year on year. Core CPI was projected to rise to 6.1% year on year.

Falling energy prices were the big driver of the drop in CPI, plunging 4.6% month on month. Gasoline prices dropped 7.7% in July.

But it wasn’t all good news. Food prices continued to skyrocket, rising 1.1% from June. Rents also rose.

And as I mention every time I talk about CPI, it’s even worse than these numbers suggest. This CPI uses a government formula that understates the actual rise in prices. Based on the CPI formula used in the 1970s, CPI remains in the 17% range — a historically high number.

How Will the Fed Play This?

After the Fed hiked rates 75 basis points last month, I asked, “Has the Fed reached the end of its rope? Will this be the last hike in this cycle?”

Despite White House and media spin, the US economy is in a recession. The most recent Fed rate hike will likely exacerbate the economic malaise.

This economy was built on easy money and debt. It looks like taking away the easy money punch bowl has already popped the bubble. This latest rate hike will only make the rip in the bubble bigger, letting the air out even faster. It’s only a matter of time before the entire house of cards economy collapses.

My guess is that privately, the central bankers at the Fed are looking for a way to get out of the corner they’ve backed themselves into. They don’t want to keep tightening into a recession. And they never really had the stomach for this inflation fight to begin with. The lackluster balance sheet reduction process reveals their queasiness to really do what it takes to slay the inflation monster.

On the other hand, the central bankers are worried about their credibility. They have continued to talk tough on inflation despite the sagging economy. Before this CPI report, there was even talk of a full 1% rate hike at the September meeting.

The Fed has two choices.

1. Keep tightening and risk completely blowing up the bubble economy
2. Ease off tightening and allow inflation to keep running rampant.

Neither option is particularly inviting in the long run.

So, the question is was this easing in CPI enough to justify a Fed pivot?

It may well depend on the economic data that comes out in the next several weeks. If the economy continues to deteriorate, the Fed can couple that with “cooling inflation” to justify slowing its roll.

At this point, the mainstream seems to think the Fed will at least ease off the gas. The thinking is the FOMC will deliver a 50 basis-point hike in September instead of another 3/4% hike. Stock futures soared immediately after the CPI report came out on that prospect.

But it’s hard to tell exactly how the central bank will play this because it’s pretty clear that the Fed is winging it. The central bankers don’t have a real plan. It’s in total reaction mode.

In reality, the Fed has already driven rates to the limit. If rates go higher, there is every reason to believe the economy will completely implode. In 2018, 2.5% was the max. We’re there now.

If you recall, the last time the Fed pushed rates this high, the economy got shaky, the stock market crashed, and the Fed went right back to loose monetary policy. (Not that 2.5% interest rates are particularly tight.) In 2019, the Fed cut rates three times and had already gone back to QE – even before the pandemic.

So, what makes anybody think the Fed can push rates to 3 or 3.5% today with even more debt in the economy?

The central bankers have to know that. I’m certain they want to take their foot off the gas. I’m just not quite sure this CPI report will offer enough cover to ease their credibility worries.

Peter Schiff summed up the situation in a Tweet.

Paradoxically investors are selling dollars and buying #gold on a lower than expected rise in July #CPI, as they think the #Fed will adopt a less aggressive policy. They're right to sell dollars and buy gold, but for the wrong reasons. The decline in #inflation is only temporary.

— Peter Schiff (@PeterSchiff) August 10, 2022

Time will tell.