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“Slightly Cooler” CPI Report Sparks Market Rally, Treasury Yields End Flat on the Day

The July CPI report indicated an 8.5% annual inflation rate, and flat for monthly inflation rate. Gasoline led the decline with a 7.7% drop monthly, but that was offset by increases in food (1.1%) and shelter (0.5%). These numbers were softer than estimates. Markets rallied accordingly on hopes that inflation had peaked. Markets also cheered Monday’s inflation expectations survey from the NY Fed: the median expectation of inflation over the next 3 years dropped to 3.2%. Down from 3.6% last month, and 3.9% in May. That is critical as consumers’ expectations of rising prices can become a self-fulfilling prophecy. The 10-Year Treasury dropped to 2.70% this morning and then settled back up to about 2.78%. Today’s auction of 10-Year Treasurys saw the highest demand in 6 months, a good sign. As far as inflation peaking, it will take multiple months of trending for the Fed to be comfortable that their rate increases have been effective (remember the Fed target is 2.0% annual inflation). Futures markets are already pricing in less hawkish Fed behavior: the futures market shifted from predicting a 75 point increase at the next meeting to a 50 point increase. Tomorrow’s PPI report will be closely watched along with Fed President Mary Daly’s speech. Stay tuned…

By David R. Pascale, Jr. , Senior Vice President at George Smith Partners