US CPI has dropped, but there are still "two major concerns"

The "optimistic" inflation data in the United States still raises concerns, and the market should not be too happy too soon!

The CPI data released on Thursday showed a continued cooling trend in US inflation, with the lowest monthly growth rate in core CPI in over two years. This data increases the possibility that the Federal Reserve will not raise interest rates next month and strengthens market expectations of a "soft landing" for the US economy.

However, investors still need to be cautious as there are two major concerns about current US inflation: core CPI and core PCE have not yet reached the Federal Reserve's 2% target, and energy prices have started to rise again in July.

In addition, there is clear internal dissent within the Federal Reserve, with some officials believing that an early pause in rate hikes could lead to a resurgence in inflation.

Currently, the CME Group's "FedWatch" tool shows an 89% probability that the Federal Reserve will hold rates steady in September, with rates remaining at 5.25%-5.5%. It is worth mentioning that a new CPI report and employment report will be released before the Federal Reserve's rate decision in September.

Two Concerns about Inflation Data

Will Compernolle, a macro strategist at FHN Financial, believes that caution should be exercised regarding the July CPI for two reasons:

First, the 4.7% year-on-year growth rate of core CPI (excluding food and energy prices) is still more than twice the Federal Reserve's 2% target, and core PCE is also significantly higher than the Fed's target of 2%. The Fed's target is PCE, not CPI, and the main differences between the two lie in the components such as airfares and medical services.

Second, the rise in energy prices starting in late July is expected to push up the overall inflation rate from the data to be released next month, posing upward inflation risks to the core index, as energy factors will transmit to energy-intensive industries such as manufacturing and transportation services.

Compernolle points out that overall, the July CPI is a very encouraging inflation report. It raises hopes for a soft landing and strengthens market expectations of the Fed's pause in rate hikes. However, there are still some inflation risks in the coming months, as the core inflation rate has accelerated again shortly after declining.

Clear Dissent among Federal Reserve Officials

There has always been dissent within the Federal Reserve regarding rate hikes, with one camp believing that the rate hike mission has already been accomplished, while another camp believes that an early pause in rate hikes could lead to a resurgence in inflation.

Federal Reserve Bank of San Francisco President Daly said on Thursday that the Fed has "more work to do" to achieve its inflation target. Earlier this week, Fed Governor Bowman reiterated that further rate hikes are needed for full price stability, while Philadelphia Fed President Harker said officials may hold rates steady. After new evidence suggests a slowdown in inflation, the possibility of the Federal Reserve keeping interest rates unchanged at the next meeting is increasing. However, they will cautiously indicate that the anti-inflation work is not yet complete. Recently, all Federal Reserve officials have stated that monetary policy actions will depend on the data released next.

In response to this, LH Meyer/Monetary Policy Analytics economist Derek Tang said:

The Federal Reserve does not need to raise interest rates in September to please those who hope that the doves will no longer prevail. Even hawkish officials, as long as the door to rate hikes is not completely closed, will accept a pause in rate hikes until November or later in the face of current data.

Diane Swonk, Chief Economist at KPMG, believes that the slowdown in price growth in July is enough for the Federal Reserve to maintain a wait-and-see approach in September, but not enough to declare victory. Prior to the interest rate meeting on September 19-20, the Federal Reserve will also see a new CPI report and employment report.