July CPI was a continuation of what we saw in June, where prices across categories increased at rates much more in-line with pre-pandemic trends compared to the higher inflationary periods during and after the pandemic (2020-2022). This month further substantiated the view that if we're not already back to "normal" inflation levels (~2%), we're a lot closer to it than many people think. Let's review this month's data.
July's CPI rose 0.2% month-over-month, seasonally adjusted, on both the core and headline. This was in-line with expectations. As a reminder, core CPI excludes food and energy prices, as those tend to be more volatile over time. Core CPI gives a better indication of underlying inflation in the economy away from that volatility. Year-over-year (less relevant, as we've talked about in prior posts), headline CPI increased 3.2%, while core increased by 4.7%.
As we normally do, let's focus on the month-over-month, seasonally adjusted number, since that gives us the best indication of current, on the ground, or "run rate" inflation. This month's 0.2% was actually 0.15% unrounded, which was the lowest monthly increase in this metric since August 2021 (during the COVID Delta variant flare up). This month's +15 bps included contributions of -9 bps from Goods, +6 bps from services ex. shelter, and +17 bps from shelter.
Notably, new cars contributed -1 bps in July (in-line with recent months), while used cars contributed -5 bps (vs. last month's -2 bps). Thus, even excluding new and used vehicles, goods contribution on the month was negative, much more in-line with pre-COVID levels where goods inflation was essentially zero. Services ex. rent this month was a bit higher than recent months (+6 bps this month vs. 3 and 4 bps contributions in June and May respectively), but still very much in-line with pre-pandemic trends (which was roughly 7 bps a month).
Furthermore, as the CPI said in its press release, "the index for shelter was by far the largest contributor to the monthly all items increase, accounting for over 90 percent of the increase." This month's 17 bps contribution from shelter to core inflation was the same as June's, and is still elevated above pre-COVID levels of about 11 bps a month. As we've talked about in prior months, there is a lag in the way the CPI calculates shelter inflation, so given rent and home price inflation has considerably cooled over the last year, this 17 bps should continue to fall in coming months closer to the pre-COVID average. This should be a nice tailwind that's still in the pipeline, which should help increase the odds that we get further positive inflation reports in August and the months thereafter as we've seen in June and July (barring any significant changes otherwise of course). Here are the charts showing current and pre-COVID contributions for each of our three inflation "buckets" (goods, services ex. shelter, and shelter).
Over the last month, I've continued to hear people in the financial press, and people at the Fed, talk about the year-over-year inflation numbers. Almost no one refers to 1, 3, or even 6 month moving averages of monthly core CPI changes. Why this is, I'm exactly sure, but it's puzzling. The Fed I suspect still wants to use the year-over-year figures because they're bigger numbers than these nearer-dated rolling averages, and thus it helps them politically with their "tough on inflation" talk. Why so many other folks in the financial world continue to look at this on such a lagged approach though is hard to understand. If you use shorter term averages and annualize them, you see "run rate" inflation considerably below the year-over-year figures. As a reminder, the reason I think it's important to look at inflation this way is because it gives us a better sense of what's happening with inflation now. Focusing on year-over-year figures unfairly incorporates "base effects," and too heavily weights inflation that already occurred 12 months ago with what's happening currently. Those of you who are consistent readers of these posts will probably be tired of me saying this, but this concept clearly needs to be hammered home further. Go turn on CNBC today if you don't believe me. The car that is the American economy was driving on the highway in 2021 and early 2022, but we've since pulled off the highway and are no longer driving at 70MPH anymore. Thus, averaging our current speed with speeds we were driving many miles ago just doesn't make sense.
In recent months, I've argued that we are likely back to 2% inflation today. With two months of 0.2% monthly increases (both of which still included elevated shelter inflation, let's remember), you don't even need to "normalize" any specific category figures in the inflation data anymore to produce 2% inflation. Both June and July's 0.2% monthly increases, when annualized, produces annual inflation of about 2.4%, which after adjusting for CPI vs. PCE methodology differences (which typically results in CPI being about 40 bps higher than PCE), produces inflation very near or even below the Fed's 2% core PCE target. This month's data gives me further confidence that this is the case, and company commentary both before and through 2Q earnings season so far further substantiates this claim. One thing to note though: this doesn't mean prices are falling or will actually go down. That rarely happens outside of seasonality (which is why the BLS seasonally adjusts the data in the first place). What we want is price increases slowing down, or dis-inflation. This is exactly what we're seeing.
After the Fed decided to hike rates again in July, today's inflation data makes it likely that we're done with interest rate hikes--as we should be--but time will tell on that. Thankfully, as long as the Fed stops hiking, the economy seems strong enough to sustain its momentum even if the Fed just pauses from here. As we've said before, pausing is not the same as cutting or easing policy. For now now, let's appreciate the good data and keep our fingers crossed that more is on the way, which, if that plays out, makes the elusive soft landing probably the most likely outcome for the economy. We would be lucky if that was the case. I'll leave you with the other key monthly charts I often show, including category level average and median increases, as well as all the rest. See you next month!
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