The Market Today

CPI Weaker Again; U.S. “Locked and Loaded”

by Craig Dismuke, Dudley Carter

Today’s Calendar – CPI Inflation Weaker than Expected Again, Key Items Firming: July’s CPI inflation reported showed yet another weaker month of price gains than expected.  Headline CPI rose just 0.1% MoM keeping the YoY rate at 1.7% (exp. 1.8%).  Core inflation, excluding food and energy items, rose 0.1% MoM keeping the YoY rate steady at 1.7%.  This marks the fifth consecutive month that core MoM inflation has disappointed economists’ expectations, the longest stretch since a 6-month run ended in September 2005.  Driving the weaker June inflation data was a surprising downshift in housing-related and auto inflation – the core of the CPI calculation.  In fact, the majority of the CPI components showed a bit of strengthening in July relative to their 12-month trend rates, but not housing nor auto prices.


Breakdown of Price Gains by Category: Food and beverage prices rose 0.16% MoM (0.09% 12M avg. rate), apparel prices rose 0.27% MoM (-0.03% 12M avg. rate), medical care prices have rebounded solidly rising 0.42% MoM (0.21% 12M avg. rate), recreation prices rose 0.34% tripling their 12m avg. rate, education and communication prices fell only 0.05% quadrupling their 12m avg. rate, and other goods and services were close to their 12M avg. rate (0.21%) by increasing 0.13% in July.  Housing, which accounts for 42% of the Headline CPI calculation and 48% of the Core calculation, rose just 0.07% in July (0.23% 12M avg. rate).  However, this appears to be driven by one-off factors.  Rent of primary residences did slow its price growth to 0.24% MoM (0.31% 12M avg. rate) but the biggest contributor, owners equivalent rent, remained firm at 0.27% (0.26% 12M avg. rate).  The biggest disappointments in the housing inflation data were drops in lodging prices and home furnishings, down 4.2% MoM and 0.20% MoM, respectively.  In the auto industry, new and used auto prices fell a sharp 0.45% MoM (-0.14% 12M avg. rate).


Takeaway: The weaker CPI data was disappointing for the time being and affirms the general outlook that price pressures are not building in a substantive way.  However, the details of the report show that the weakness should be temporary with inflation likely to move back closer to 2% in the medium term.  Moreover, the firming in medical care inflation further bolsters the rebound argument.  Moving materially above 2% in the near or medium terms appears to be unlikely.  December is very much still in play for the FOMC.


Dallas Fed Bank President Kaplan is speaking today in Arlington, Texas and Minneapolis Bank President Kashkari is speaking at the Independent Community Bankers of Minnesota conference.  The markets are more likely to be focused on President Trump’s Twitter feed and statements coming from North Korea.  Already, President Trump has informed the North Koreans that the U.S. is “locked and loaded” in case a military response is necessary.


Overnight Activity – Markets Continue to Shun Risk as Tensions Rise: Nervous trade flows continued to signal risk aversion overnight in the face of an uncertain situation between the U.S. and North Korea and in front of this morning’s U.S. inflation data. Before the U.S. CPI report was released, European stocks had continued to exhibit weakness with the Stoxx Europe 600 down 1.0%. The pan-European index was on track for its worst week since November 2016. The slump in Europe followed another leg lower by Asian indices earlier in the day. South Korea’s KOSPI index dropped another 1.7% Friday taking its total week’s loss to 3.2%, the worst week for South Korean stocks since June 2016. U.S. equity futures were also weaker overnight. Sovereign yields reflected the risk-off tone as yields in Germany and France ticked lower while those in Italy and Spain rose. Treasury yields had moved less with the yield curve lower by less than 0.5 bp. Gold and the Yen were up but the momentum had slowed. After the CPI report was released, yields inched lower with the 2-year yield down 1.0 bp to 1.21% and the 10-year yield 0.7 bps lower at 2.19%. The Dollar slipped to its lows of the day but stock futures turned positive.


Yesterday’s Trading Activity – Ever-increasing Geopolitical Worries Tough for Markets to Swallow: U.S. stocks sold off sharply Thursday as markets’ uneasiness about tensions between the U.S. and North Korea continued to accelerate. Markets were on edge all of Thursday but the risk-off sentiment peaked after President Trump’s latest retort to North Korea’s plan for a potential strike on Guam. President Trump said his previous statement of “fire and fury” maybe “wasn’t tough enough” and added that “things will happen to [North Korea] like they never thought possible” if they attack the U.S. or one of its allies. Stocks, already down notably for the day, fell even further to close at their daily lows. The Dow fell 0.9%, the S&P tumbled 1.5%, and the Nasdaq plunged 2.1%; all were the worst performances since May 17, the day after a NYT article alleged the President had asked former FBI Director Comey to call off an investigation into Michael Flynn. The risk-off tone was clear in other markets as well with Treasury yields ending near daily lows, the Japanese Yen surging to its strongest level since June 14, and gold climbing to a more-than-two-month high. On the day, the 2-year yield fell 1.2 bps to 1.33% as the 10-year yield dropped 4.2 bps to 2.20%, leaving the curve the flattest between the two maturities since June 28.


Dudley Expects Near-Term Weakness in Inflation to Diminish in 2018: NY Fed President Dudley said Thursday that, while he expects inflation to remain weak over the near term, he does believe it will move back towards 2% over the medium term. He expects the weakness to persist until “some of these very low readings drop out of the statistics six to ten months from now”, a reference to the certain transitory factors that the Fed has indicated have caused the downturn in 2017. However, moderate economic growth, additional tightening of the labor market, and the Dollar’s doldrums should push inflation higher in 2018.

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