US CPI Preview: Softer July Inflation Could Reduce Fed Rate Hike Bets

Key Takeaways

• US headline inflation is expected to ease to 3.4% in July from 3.5% in June, while core inflation is forecast to decline to 2.5% from 2.6%.
• Markets see roughly an even chance of a Federal Reserve rate increase in September after the US unexpectedly lost 23,000 jobs in July.
• A softer CPI report could weaken the US dollar and support stocks, gold and Treasury bonds, while an upside surprise may revive expectations of additional monetary tightening.

US inflation is expected to moderate further in July, potentially strengthening the case for the Federal Reserve to leave interest rates unchanged at its September meeting.

The Bureau of Labor Statistics will release the July Consumer Price Index report on Wednesday at 8:30 a.m. Eastern Time, or 12:30 GMT. Economists expect the headline CPI to rise 0.1% month over month, reversing part of June’s 0.4% decline.

On an annual basis, headline inflation is forecast to slow to 3.4% from 3.5%. Core CPI, which excludes volatile food and energy prices, is projected to increase 0.2% during the month after remaining unchanged in June. The annual core rate is expected to fall to 2.5% from 2.6%, potentially reaching its lowest level since February.

Although both annual readings would remain above the Federal Reserve’s 2% objective, another month of moderating inflation could convince policymakers that additional interest-rate increases are unnecessary.

Lower Energy Costs Could Keep Headline Inflation Under Control

Energy prices are expected to remain an important source of disinflation in the July report.

Gasoline prices likely declined by almost 3% during the month, while lower jet-fuel costs may have contributed to cheaper airfares. Prices for hotels and other travel-related services could also have softened as demand normalized following the FIFA World Cup.

New and used vehicle prices, however, may have increased slightly. Shelter inflation will remain another important component because housing costs carry substantial weight in the CPI and have historically responded slowly to changes in market rents.

June’s report was unusually weak. Headline CPI fell 0.4% month over month—the largest decline since April 2020—after gasoline prices dropped 9.7%. Annual inflation slowed sharply from 4.2% in May to 3.5%, while core inflation fell to 2.6% from 2.9%.

Some of June’s price declines are unlikely to be repeated. Economists therefore expect monthly inflation to return to positive territory even if the broader annual trend continues to improve.

Weak Payrolls Raise the Stakes for the Fed

The inflation report follows unexpectedly weak labor-market data that complicated the Federal Reserve’s policy outlook.

US nonfarm payrolls declined by 23,000 in July, compared with expectations for an increase of approximately 83,000. May and June payrolls were also revised lower by a combined 103,000.

The unemployment rate edged down to 4.1% from 4.2%, but the decline partly reflected workers leaving the labor force. Labor-force participation fell to 61.4%, its lowest level since 2021. Average hourly earnings growth also slowed to approximately 3.2% year over year.

The payroll figures prompted traders to reduce expectations of an imminent rate increase. Interest-rate futures were pricing a roughly 48% to 53% probability of a quarter-point September hike ahead of the CPI release, leaving the market almost evenly divided.

The Federal Reserve held its benchmark rate in a range of 3.50% to 3.75% at its July meeting. Three of the 12 voting policymakers favored an increase, underscoring the level of disagreement within the central bank.

Fed Officials Remain Concerned About Persistent Inflation

Despite softer employment and inflation data, several Fed officials have maintained a cautious or hawkish position.

Chicago Fed President Austan Goolsbee recently described inflation as the economy’s most pressing problem, while acknowledging that the labor market is stable but no longer particularly strong.

Atlanta Fed interim President Cheryl Venable has also warned that the inflation outlook depends heavily on developments in the Middle East. A lasting resolution could restore energy supplies and reduce price pressures, while prolonged conflict could push oil and transportation costs higher.

These comments show why one favorable CPI report may not settle the September decision. Policymakers will receive additional data, including the July Personal Consumption Expenditures price index, the August employment report and August CPI, before their next meeting.

How Markets Could React to the July CPI Report

A result broadly matching forecasts—particularly monthly core CPI between 0.2% and 0.25%—would likely reinforce expectations that the Fed can remain on hold. JPMorgan’s trading desk estimates that this scenario could lift the S&P 500 by approximately 0.25% to 0.75%.

A weaker core reading below 0.15% could generate a stronger risk rally, potentially lifting the S&P 500 by 1% to 2%. Treasury yields and the US dollar would probably decline as traders remove additional rate hikes from their forecasts, while gold and interest-rate-sensitive technology stocks could benefit.

The opposite reaction may occur if core CPI rises more than 0.3% during the month. JPMorgan estimates that such a surprise could push the S&P 500 down by 1.5% to 2.5% as markets revive expectations of tighter monetary policy.

Currency markets were cautious before the release. The US Dollar Index held near 99.83, while EUR/USD traded around 1.1540. A softer report could encourage investors to reduce long-dollar positions against currencies including the euro, Japanese yen and New Zealand dollar.

The July CPI report therefore represents a critical test of whether the recent inflation slowdown is developing into a sustainable trend. A benign reading would give the Fed more flexibility to respond to the weakening labor market, while a hotter result could force policymakers to keep another rate increase firmly under consideration.