Weak U.S. CPI Underscores Unlikelihood of Another Fed Hike in 2017

Another underwhelming rise in the U.S. core Consumer Price Index (CPI) reported on Friday increases the chances that Federal Reserve policymakers use the September meeting to signal they plan to abstain from additional interest rate hikes until next year. After the July CPI report, we believe it is entirely possible that core PCE (personal consumption expenditures, the Fed’s preferred inflation measure) ends the year running at 1.3% year-over-year, which is meaningfully below the Fed’s June median forecast for 1.7%. Despite the dimming outlook for an additional policy rate hike in 2017, we continue to believe the Fed will begin to gradually shrink the size of its balance sheet sometime in the second half of this year.

Persistent core CPI weakness

July’s 0.11% month-over-month core CPI print was softer than consensus expectations – primarily due to the largest-ever one-month drop in hotel prices (−4.2%), which is unlikely to repeat. Still, it follows a string of weaker-than-expected reports, raising questions about the extent to which softer inflation is indeed transitory.

Meaningful trends toward weakness in core goods prices

Ingrained deflationary trends across several core goods categories continued. New and used auto prices declined 0.5%, and we expect pricing weakness to continue into the second half of the year as the auto industry works through oversupply issues. The glut of used cars coming to market after the increased pace of consumer leases over the last several years and the generally weaker-than-expected trends in business and consumer purchases of new autos have generally increased vehicle inventories and weighed on prices.

Meanwhile, deflation in retail goods prices also continued in July, in what appears to be a more meaningful trend. July’s weakness was likely exacerbated by Amazon’s Prime Day on July 11, which reportedly induced heavy discounting among other retailers. However, the broader disruption of the retail sector from rising e-commerce competition is also likely having an impact.