US CPI data set to show softer inflation in July as markets reassess Fed rate hike bets

On Wednesday, the US Bureau of Labor Statistics will release the July Consumer Price Index (CPI) figures, which are anticipated to reveal a slight decrease in both consumer and core inflation rates. The monthly CPI is projected to increase by 0.1%, from the 0.4% decline seen in June, while the annual figure is expected to fall to 3.4% from 3.5% in the previous month. Core CPI, which excludes volatile food and energy prices, is projected to rise by 0.2% monthly and 2.5% annually.

Following a 16% drop in May, crude oil prices decreased by around 20% in June before rebounding to pre-war levels due to the ceasefire agreement between the US and Iran on June 17. Consequently, CPI inflation moderated more rapidly than initially anticipated in June. TD Securities anticipates that July's inflation data will exhibit a mild uptick after the temporary softness observed in June.

The bank predicts that "July core CPI likely rebounded after June's one-off weakness, rising 0.20% month-over-month as services inflation reaccelerates, led by rents/OER, airfares, medical, and recreation." TD also notes that "core goods likely posted their first increase in three months," while "headline CPI may rise by 0.15% month-over-month, driven by lower gasoline prices offset by faster grocery price growth."

The US Federal Reserve holds a dual mandate to maintain price stability and maximum employment, with inflation targeted at around 2% year-over-year. The central bank's efforts to curb inflation have been intensified due to supply-chain issues and bottlenecks, with the Consumer Price Index (CPI) hovering near multi-decade highs. Despite the recent agreement between Iran and Oman to manage the Strait of Hormuz, crude oil prices surged by nearly 22% in July.

However, the news of Iran and Oman working on a deal to open the waterway led to a decline in oil prices in the early weeks of August. Coupled with disappointing US Nonfarm Payrolls data, which showed a surprising 23,000 decrease in jobs, investors have reduced expectations for a Federal Reserve rate hike in September.

Currently, markets anticipate a 52% probability of a 25 basis points (bps) interest rate increase at the next policy meeting, as per the CME Group FedWatch Tool. However, market participants remain cautious about a policy hold, given the recent rise in oil prices and Iran's insistence on specific conditions before resuming activity in the Strait of Hormuz.

Analysts at OCBC argue that the conditions for a significant shift in Fed expectations remain stringent, emphasizing that "core CPI would need to print at 0.3% month-over-month or higher in July, surpassing the current 0.2% consensus forecast, to significantly boost expectations of a September rate hike." They also acknowledge that "a rangebound USD, coupled with a constructive risk backdrop, should continue to support carry trades despite persistent volatility in oil markets."

Recent easing in oil prices, driven by expectations of reopened Strait of Hormuz, implies that energy markets may remain uncertain, keeping the outlook for energy markets tentative.