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The spiral of inflation breaking in July was helped by lower fuel prices

People shop at a supermarket as inflation affects consumer prices on June 10, 2022 in New York City.

Andrew Kelly | Reuters

Inflation may finally be cooling, thanks to lower gasoline prices and fading supply chain issues.

According to Dow Jones, economists expect July’s consumer price index to have risen 0.2% from 1.3% in June. On a year-over-year basis, the pace of consumer inflation is expected to drop to 8.7% in July from 9.1% in June.

The CPI is reported at 8:30 am ET on Wednesday and is expected to show that inflation has finally peaked. Investors are closely watching the report for clues about how aggressive the Federal Reserve will be in raising interest rates to fight rising prices.

“You have about four drivers of inflation right now. You have commodity prices. That’s going away. You’ve got supply chain issues. That’s going away, but you’re still left with housing and the labor market and that’s going to show up as services inflation,” said Aneta Markowska, chief economist at Jefferies. “You still have a problem with services inflation, and that’s driven by housing and labor shortages. That’s not going away anytime soon unless the Fed manages to destroy demand, and that’s not going to happen.”

Excluding fuel and food, CPI is expected to rise 0.5% in July as prices of rents and services rose, but that was down from 0.7% in June. Core CPI is still expected to be higher year-on-year than in June, gaining 6.1% from June’s 5.9%.

“Everyone prefers reasonably good news, so this has to be good news. If it’s not as good as people think, it’s going to be unusually bad news,” said Mark Zandi, chief economist at Moody’s Analytics.

Zandi said he expects core inflation to rise by just 0.1%. “It’s 8.7% year-on-year, uncomfortably high, painful but moving in the right direction. I think the 9.1% inflation rate we experienced in June will be a peak… a lot depends on oil prices,” he said.

Inflation expectations are falling

The report comes as consumer and market expectations for inflation are falling. A survey by the New York Federal Reserve this week showed that consumers expect inflation to move at a 6.2% pace over the next year and at a 3.2% annual rate for the next three years. That’s a big drop from the June survey results of 6.8% and 3.6%, respectively.

“That’s one of the most positive aspects of the inflation situation — inflation expectations have come in. Consumer expectations have come in, not surprisingly with lower gasoline prices,” Zandi said. “But more importantly, bond market expectations have come back… They’re back within spitting distance of the Fed target. That’s a really good sign.”

Bond market metrics for inflation, such as the 10-year breakeven, show that investors see slower inflation than they did just a couple of months ago. The 10-year breakeven is now 2.50%, down from 3.07% earlier this year, according to Ian Lingen, head of US rates strategy at BMO Capital Markets.

That means market participants now expect an average inflation rate of 2.50% annually over the next 10 years. Risks around the July CPI lean toward a lower-than-expected number, Lingon said.

“There are a number of wild cards that we have a particularly strong view of, which are in line with peak inflation and will be traded accordingly,” he said.

Oil is the wild card

One wild card is oil, and while it has been falling recently, market views differ on what will happen later in the year. The price is highly dependent on geopolitical events and how much the global economy slows down. August has seen some of the lowest oil prices since Russia’s invasion of Ukraine, with West Texas Intermediate crude futures trading around $90 on Tuesday, near $130 per barrel since March.

In June, the CPI energy index rose 7.5%, with gasoline alone rising 11.2%.

Gasoline prices fell through July and are down nearly 20% from a June 14 peak of $5.01 per gallon. The national average price for a gallon of gasoline was $4.03 per gallon on Tuesday, according to AAA.

Housing costs are expected to increase in July. In June, the rent index rose 0.8%, the largest monthly increase since April 1986.

“It’s not coming. It’s going to remain persistently high through at least next year. We could see a nasty acceleration of housing costs toward the end of the year,” Zandi said.

A twin improvement in demand supply and cooling means rents may eventually moderate, Zandi said.

“One reason is demand is hurting. People can’t afford these rents … and the other is supply. Multi-family construction is strong,” the economist said.

“That will show up in the housing CPI, but it won’t be until next year,” he said. “It adds half a factor to inflation for the foreseeable future. We have inflation of 2.5% in CPI in the spring of 2024. But half of that factor is housing.”

Markowska said consumers got a break in July travel costs, which fell from the peak of spring and summer. In July, they expect the CPI airfare index to fall 7.7% month-on-month, taking 0.1% from core CPI.

So far, car prices aren’t going down, Markowska said. “We seem to have very low inventory levels. I’m not looking for big gains there. Used car prices, they’ve gone up two months in a row. I think they’ll post another increase this month and new car prices will go up as well,” she said. Prices seem to be stabilizing, he said. “I think a lot of people are expecting us to reverse some of the price gains.”

Supply chain issues are easing, he said. “You see clearly in a lot of indicators – ISM indices, prices paid are coming down, delivery times are coming down. Traffic in the Pacific is down from what we saw last year. We’re really in the peak shipping period. Everything seems to be moving in the right direction,” he said.

Economists say it’s important to watch the Federal Reserve reduce inflation. But this is just one report, and the Fed will look to the next jobs report for August and the August CPI before raising interest rates again in September.

Lingen said all those numbers will determine whether the Fed raises rates by 50 basis points before Friday’s strong jobs report, in line with June and July hikes, or 75 basis points as expected. The economy added 528,000 jobs in July, double what economists had predicted. One basis point is equal to 0.01 of a percentage point.

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