July CPI: Mostly as Expected, Including More Tariff Passthrough

Inflation is haltingly drifting back to target, but the trade war isn't helping.

July’s Consumer Price Index came in mostly as expected, with the yearly headline a touch below expectations (2.7% actual vs. 2.8% exp) and the yearly core slightly above (3.1% vs. 3.0%). On a monthly basis, inflation was up 0.2% and 0.3% for headline and core, a tick-down of the former from June and a tick-up for the latter. Headline inflation was nudged down by a 1% monthly decline in energy prices led by a 2% monthly decline in the gasoline price.

Cutting to the chase, here are three related questions: are the tariffs in here, what does this report mean for the Fed’s September meeting, and what’s the broad inflation outlook?

—You can see tariff effects fairly clearly in this report, but let’s not forget that imported goods are but 11% of US GDP, so no one should expect tariffs to be blasting the roof off of inflation. A more rational expectation would be that goods will see some price pressures, those pressures could spill over into other sectors, and in a sweeping-tariff environment, getting back to the Fed’s target will be harder than would have been the case pre-trade war.

Here’s a bar chart of yearly core goods prices this year. I’d put this on tariffs (see Ernie T’s twitter feed for other such figures). See also furniture, footwear, coffee (!!).

Other evidence suggests tariff passthrough to consumers is growing. A new GS report finds “that US consumers had absorbed 22% of tariff costs through June but that their share will rise to 67% if the recent tariffs follow the same pattern as the earliest ones.”

—What does this mean for the Fed’s meeting next month? The market-based probability of a 25bps cuts went up from 86% yesterday to 94% this morning. That tracks to me, and more importantly to Nick T:

A September rate cut could've been derailed by a hot CPI print today. The July CPI wasn't a "no inflation" reading, but it likely wasn't hot enough to stop a September cut.

If the job market were soaring, I’d be less convinced that a Sept rate cut is coming, but given what looks like significantly slower job growth and inflation not surprising bigly to the upside, a small, defensive cut seems like the right play.

SNARKY INTERLUDE: I haven’t heard any of the Trumpies react to this data but if they say anything positive about it, and reporter who fails to ask this question is fired: “Um…you guys know the CPI data is also from BLS. Why do you believe it?”

—So, what’s the broad inflation outlook? As you see below, both headline and core are well off their peaks from ‘21-’22 spikes but not back to pre-pandemic growth rates. Some of that stickiness is the result of slowly normalizing prices following the pandemic-induced spikes.

Housing inflation is progressing back to pre-pan levels and is almost there, but core services are taking their time to get back and recently turned up a bit. And, as noted above, the tariffs are boosting goods prices.

Bottom line, not up front, is that inflation is slowly and stickily heading back to pre-pandemic rates, but the trade war is more than a speed bump. It’s raising prices of both intermediate inputs and final goods, and consumer passthrough is accelerating. Inflation therefore is and will be higher than would otherwise be the case. Forthcoming Fed rate cuts should help avoid a sharp economic slowdown, but Trump policies are generating economic headwinds while making life more expensive for American families, and I’m afraid that’s not going anywhere for awhile.