In Line CPI Puts Fed on Hold

CPI printed in line with headline at .1% and core at .2%.  Food inflation was cool at .1%, gasoline dropped 2.9% but airline fares were still up 2.2%.  The important shelter component was up only .1% but only because hotel prices dropped 2.5%, both owners equivalent rent and regular rents were up .3% despite the fact that market rents are down year over year.   Importantly year over year core CPI dropped to only 2.5%, which is in line with the Fed’s 2% target.   CPI implies PCE core will print at a benign .2% for July. We forecast that year over year CPI will drop to 2% over the next year as the deeply flawed shelter component gradually reflects market rents.  Our CPI-R core reading, which uses market rents, is tracking below 1%.

The in-line CPI print takes a Fed hike off the table as the 3-month annualized core CPI is now only 1.6% and the year over year CPI core has dropped from 2.9% to 2.6% over the last 3 months.  In addition, core CPI is elevated by airline fares which should actually be removed from core as airline fares are almost exclusively driven by energy prices.  Although PCE Core is elevated at 3.3% it is heavily distorted by deeply flawed imputed price estimates that result in completely irrational outcomes such as portfolio management rising 21% and financial services up 9% Y/Y.   We are confident that the Fed will adopt CPI Core as their preferred inflation gauge after the task forces issue their reports.