Core inflation continues at 5.9%, an unsustainable rate.
By David Enna, Tipswatch.com
I warned you: Inflation numbers are notoriously fickle in the summer months, and so here we go: All-items U.S. inflation increased 0.0% in July on a seasonally adjusted basis, the Bureau of Labor Statistics reported today. The year-over-year number dipped to 8.5%, down from June’s 41-year-high of 9.1%.
Inflation was expected to dip in July because of a strong drop in gasoline prices, a trend that continues in August. But today’s inflation numbers were well below the consensus estimates of 0.2% for all-items and 8.7% for the annual rate. Core inflation, which removes food and energy, came in at 0.3% for the month and 5.9% for the year, also below consensus estimates.
For American consumers, this is good news. We seem to have finally passed “peak inflation” and prices are heading down. But keep in mind that annual inflation is still running at 8.5%, a dangerously high number.
The BLS noted that gasoline prices fell 7.7% in July, after increasing 11.2% in June, and still remain 44% higher than a year ago. The decline in gas prices helped offset a 1.3% increase in the cost of food at home, now up a painful 13.1% over the last year. June was the seventh consecutive month where food prices increased 0.9% or more.
Other notable trends:
- Shelter costs increased 0.5% in July and are up 5.7% year over year. The rent index rose 0.7% in July. The BLS said shelter costs accounted for about 40% of the increase in core inflation.
- Costs for used cars and trucks dipped 0.4%, but are still up 6.6% over last year’s highly elevated prices.
- Prices for new vehicles increased 0.6% and are up 10.4% for the year.
- The index for natural gas declined in July after sharp recent increases, falling 3.6%. (Let me know when you see your natural gas bill decline in response.)
- The medical care index rose 0.4% in July after rising 0.7% in June, and is now up 5.1% year over year.
- The index for airline fares fell sharply in July, decreasing 7.8%.
So, while overall inflation was down in July, the complete picture remains complex. Gas prices down, food prices up and everything else … mostly up, with core inflation continuing to run at 5.9%. Here is the 12-month trend for all-item and core inflation, showing that while overall inflation seems to have peaked, core inflation appears locked in at around 6.0%:
What this means for TIPS and I Bonds
Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances of TIPS and set future interest rates for I Bonds. For July, the BLS set the CPI-U index at 296.276, down 0.01% from June’s number of 296.311.
For TIPS. July’s inflation report means that principal balances for all TIPS will decline by 0.01% in September, after rising 1.1% in July and 1.37% in August. Over the year ending in September, TIPS principal balances will have increased 8.5%. Here are the new September Inflation Indexes for all TIPS.
For I Bonds. The July report is the fourth of a six-month string that will determine the I Bond’s new variable rate, which will be reset November 1. As of now, inflation has increased 3.05% in that four-month stretch, which would translate to a variable rate of 6.1%, very attractive but well below the current rate of 9.62%. Two months remain, and a lot can happen in two months. Stay tuned. Here are the numbers so far:
What this means for the Social Security COLA
The July inflation report is the first of three — for July to September — that will set the Social Security Administration’s cost of living adjustment for 2023. The SSA uses a three-month average of a different index, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), to set its COLA.
For July, the BLS set CPI-W at 292.219, an increase of 9.1% over the last 12 months. However, CPI-W actually fell 0.1% for the month. But remember, it will be the average of July to September inflation indexes — compared to the same three-month average a year ago — that will determine the Social Security COLA. A year ago, that average was 268.421. July’s number was 8.9% higher. If we have zero inflation in August and September, the COLA will be 8.9%
In a recent article, I predicted that the 2023 COLA would get an increase of 9.9% to 10.1%. That could still happen, but the current trend in gas prices should push the number lower. We’ll see. Last year, July inflation ran fairly hot (about 0.5%) but then cooled off in August and September. Here are the historical numbers used in this COLA calculation:
And here is my updated projection for the Social Security COLA in 2023, factoring in the slight deflation in the July index:
What this means for interest rates
The Federal Reserve can’t steer away from its inflation-fighting course, but the July report gives it a little breathing room. It looks like year-over-year inflation has finally peaked. But notoriously volatile gas prices are the primary reason for the dip, and food prices continue to soar. It’s significant that for the first time in many months, inflation came in under consensus estimates. The stock market is happy, with the S&P 500 index already up about 1.6% at 9:35 a.m. EDT.
There should be no “declaring victory.” Inflation remains very close to a four-decade high and cannot continue even at the core rate of 5.9%. Reducing inflation will continue to be Job No. 1 for the Fed. Could we see a 50-basis-point increase in short-term rates in September, instead of 75? I think July’s inflation report made that more possible.
From this morning’s Wall Street Journal report:
Rapidly rising prices have become persistent following a surge in inflation from goods, energy and food, said Greg Daco, chief economist for EY-Parthenon, a consulting firm.
“That divergent trend shows there’s a breadth of inflation in that housing inflation and service-sector inflation remain elevated,” he said, adding price pressures in those areas could linger. “And those tend to be stickier than goods, which can and will start to reverse.” …
“Even if headline inflation slows on account of weaker energy prices but core inflation is stubbornly high, the Fed is likely to maintain its tightening bias as it will be concerned about high inflation being entrenched in consumer price expectations,” said Blerina Uruci, U.S. economist at T. Rowe Price Group Inc.
The inversion in nominal yields continues this morning, with the 26-week Treasury yielding 2.99%, the 2-year at 3.11% and the 10-year at 2.72%. The bond market is predicting economic weakness, which will make the Fed’s job even more difficult.
* * *
Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.