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The U.S. Bureau of Labor Statistics released the July inflation report on Wednesday, with data coming in fully in line with market expectations, further cementing investor bets that the Federal Reserve will hold rates steady at its September meeting.
Data showed that the Consumer Price Index rose 0.1% month-over-month and 3.4% year-over-year, while core CPI rose 0.2% month-over-month and 2.5% year-over-year — all exactly matching median economist estimates. On a component basis, food prices rose 0.1% month-over-month, energy prices gained 0.3%, and shelter costs increased 0.1%, with overall increases remaining moderate.
Market Pricing Shifts Rapidly
Following the inflation report, rate expectations adjusted quickly. According to the CME Group’s FedWatch tool, as of the morning of August 12, markets priced a nearly 62% probability that the Fed would maintain its current 3.50%-3.75% rate range at the September meeting — up from roughly 52% just one day earlier. Meanwhile, the probability of a September rate hike fell from over 48% to about 38%.
This shift did not occur in isolation. Last week’s July nonfarm payrolls report showed that the U.S. economy unexpectedly shed 23,000 jobs, falling well short of expectations and providing the latest evidence of a cooling labor market. Ellen Zentner, Chief Economist at Morgan Stanley Wealth Management, noted that with the jobs report already fueling a “no need to hike” narrative, the in-line inflation data would reinforce that view.
Data Combination Supports Policy Pause
Looking at the monthly trajectory of core inflation, July’s 0.2% month-over-month increase was roughly in line with the average of the past year. Despite the Iran war continuing to drive energy price volatility, core inflation showed no signs of acceleration. It is worth noting that while core CPI excludes food and energy components, higher energy prices can still feed through to final consumer prices by raising business operating costs — a risk the Fed still needs to watch.
That said, with the current data combination — modest inflation and weakening employment — the Fed still has at least three key reports to consider before its September 17-18 meeting: the July Personal Consumption Expenditures (PCE) Price Index, August nonfarm payrolls, and August CPI. This means the policy path is not yet fully locked in.
Looking Ahead: Data-Dependent Logic Remains Intact
Although market expectations have tilted toward a pause, the Fed is not of one mind — three voting members dissented in favor of a rate hike at the July meeting. If subsequent data show an inflation rebound or unexpected labor market strength, rate-hike expectations could resurface.
For investors, the most critical factor to watch is not any single data point, but the overall direction of the data combination. With shipping through the Strait of Hormuz blocked and geopolitical risks continuing to simmer, the trajectory of energy prices may prove to be the single biggest variable shaping the inflation outlook. Until the September meeting, anything remains possible.
