July US CPI: Has inflation peaked (again)?

Tomorrow's data could not only be the most important this week, but for the whole month. As we anticipated in Friday's NFP podcast, there is a lot riding on US inflation data. That is particularly the case after the Fed promised to take a data-dependant approach. And of course inflation is the most important of that data.

The issue for traders is that there are a bunch of moving parts which could all push the market to react in different directions. On the one hand, the media is likely to focus on the headline figure, because that's what's most important to consumers. But the market cares more about what the Fed will do at their next meeting, so the focus will likely be on core inflation. And the kicker? Well, both of these numbers are expected to go in opposite directions.

Some factors to keep in mind

Before jumping into the expected results, there is some context that needs to be taken into account. First, the Fed is on its unofficial summer break, and won't meet again until late September. That means we'll get August inflation numbers before the meeting, which could modify some of the outlook for monetary policy. Thus, the market reaction could fade a little as investors assess the possibility of a correction a month from now.

The other factor relates to the headline CPI. The prices that are used to make the calculation are sampled at different times of the month. Fuel costs have been one of the driving factors in inflation, and they went down through the course of July. But fuel price sampling happens at the start of the month, so this headline inflation number is likely not to capture the full effect of the price change.

What to look out for

Another thing to keep in mind is that the market is likely to care more about the "faster" data. That is month-over-month comparisons that show where things are going right now. Particularly looking for some effect from the Fed's aggressive tightening. Rates have been rising since March, so there has been time for the effects to start filtering into the market.

Headline CPI change is expected to seriously hit the breaks in July, with monthly change of 0.2% compared to 1.3% in June. That is expected to contribute to the forecast for July annual inflation to step back to 8.7% from 9.1% prior.

What does it mean?

Of course this isn't the first time there has been a pull-back in inflation for one month. So, it doesn't necessarily mean a peak has been reached. But after Friday's NFP, it could contribute to hope that it might have, and there will be anticipation for next month's number to start showing a trend.

On the core side, things aren't so rosy. Monthly core inflation is expected to slow down, but not by nearly as much to 0.5% from 0.7% prior. Where the problem could be is with annual core inflation expected to rise to 6.1% from 5.9% prior. That could leave us in a situation where the headlines will be talking about lower inflation, but the Fed keeps pushing for higher rates to deal with core inflation.