US inflation cools further as CPI and PPI ease, reducing Fed rate-hike expectations

The latest U.S. inflation data provided some relief for financial markets this week, with both consumer and producer price pressures showing signs of moderation. While inflation remains above the Federal Reserve’s 2% target, the combination of softer CPI and PPI readings, alongside a weakening labor market, has reduced expectations for another Federal Reserve rate hike in September.

CPI inflation cools slightly

The U.S. Consumer Price Index (CPI) increased 3.4% year-on-year in July, down from 3.5% in June and exactly in line with market expectations. Core CPI, which excludes food and energy prices, eased to 2.5% from 2.6% previously.

Although the decline was modest, the direction is important. Inflation is continuing to cool rather than accelerate, providing the Federal Reserve with less urgency to tighten monetary policy further. The latest figures therefore represent a slightly more favorable inflation environment for markets, particularly when combined with growing evidence of weakness in the U.S. labor market.

The reaction in interest-rate markets was significant. Following the CPI release, the probability of a 25-basis-point Fed rate hike at the September meeting fell to around 38–39%, from approximately 48% before the report, according to market pricing and CME FedWatch.

This shift is particularly important for gold. Gold tends to benefit when expectations for higher interest rates decline because lower-rate expectations reduce the opportunity cost of holding a non-yielding asset such as bullion. The softer CPI therefore provided a supportive backdrop for gold, especially given that the labor market has also been showing signs of deterioration.

A weakening labor market adds to the case for a Fed hold

The inflation data cannot be viewed in isolation. The latest employment figures have added another important piece to the Federal Reserve’s policy dilemma.

The July Nonfarm Payrolls report showed that the U.S. economy lost 23,000 jobs, dramatically missing expectations for an increase of around 80,000. Even more importantly, previous employment figures were revised significantly lower: May payroll growth was revised from 129,000 to 63,000, while June was revised from 57,000 to just 20,000. Combined, the revisions reduced previously reported employment growth by 103,000 jobs.

The labor market has therefore weakened for two consecutive months in terms of the latest payroll data, while the downward revisions suggest that the deterioration may be broader than initially reported.

For the Federal Reserve, this creates a difficult balance. Inflation remains elevated, but the labor market is losing momentum. Raising interest rates further could help contain inflation, but it could also place additional pressure on an already weakening employment environment.

This is one reason why the softer CPI reading was particularly positive for gold: the market is increasingly seeing less justification for another rate hike while simultaneously seeing greater downside risks to economic growth.

PPI: Another sign of cooling producer inflation

The Producer Price Index (PPI) delivered an even more noticeable moderation in annual inflation.

U.S. producer prices were unchanged month-on-month in July, while expectations were pointing to an increase by around 0.2%. On a year-on-year basis, PPI slowed sharply to 4.7% from 5.5% in June.

The 4.7% annual producer inflation is still high, and the rise in services prices indicates that underlying inflation pressures have not disappeared. Moreover, the PPI report may not fully capture the sharp increase in oil prices that occurred toward the end of July, meaning energy-related inflation risks could return in future readings.

Ultimately, cooling inflation and a weakening labor market have significantly reduced expectations for a September rate hike, with markets now pricing the probability of a hike at around 39%. For gold, this shift in the Fed outlook is a positive development, particularly if incoming economic data continue to confirm that inflation is gradually cooling while labor-market conditions deteriorate.