Underlying Price Pressures Remain

MACRO FRAME

July’s inflation report suggests that underlying price pressures remain firm, favoring a hawkish stance from the Fed even absent the geopolitical backdrop.

STOCK INDEX FUTURES

Equity index futures were little changed following the release of July’s CPI report, which saw headline CPI rise 0.1%, while core rose 0.2%, both matching consensus forecasts and offering somewhat of a favorable near-term inflation outcome. However, underlying inflationary pressures continued to mount, with services-ex energy up 0.2% MoM at 3.0% YoY, suggesting that the overall profile of inflation is remaining sticky, regardless of energy prices. The CPI print does offer a useful guide to the potential timing of disinflation once the Iran war ends and if energy-related price pressures begin to fade more sustainably. However, next month’s reading will likely reflect the rebound in energy prices over the past month, and with a near-term resolution appearing increasingly unlikely, renewed energy pressures could keep upside inflation risks elevated and strengthen the case for a Fed hike. Oil prices were little changed overnight despite reports of an attack on a shipping vessel in Bab el-Mandeb, underscoring the risk of disruption across two critical shipping chokepoints. Meanwhile, Iran’s top security official maintained that the Strait of Hormuz will remain closed until Washington accepts Tehran’s conditions, including the release of frozen Iranian assets, an end to regional conflicts, and a change in U.S. policy toward Iran. The comments provide the clearest indication yet that a near-term reopening remains unlikely, while Iran’s discussions with Oman over shipping lanes appear focused on limited access rather than a full reopening of the strait.

Watch point: Equity volatility is being driven by increasingly concentrated bets in tech and semis, and that argues for a deliberate shift toward industrials and broader, real‑economy exposure amid the renewed fighting.

CURRENCIES

US DOLLAR: The USD index held is near the 99.60 following July’s inflation data, as traders pushed back expectations of a September rate hike and as front-end yields moved lower. Still, the report showed that underlying inflationary pressures remained firm, which is likely to reinforce hawkish Fed members views that policy should move upwards. For the market, traders took the fact that the print came in line with expectations as reason to push out tightening expectations, leaving the dollar to weaken off reduced policy-spread differentials against the EUR. The low-hire, low-fire regime is likely to keep expectations of a hike within the next four meetings intact, with the labor market acting as a non-factor in the Fed’s decision despite July’s sluggish hiring. Near-term guidance on the labor will shift to weekly claims data, which has remained remarkably low. However, a pickup in claims toward the 300,00 – 400,000 level would warrant recessionary worries.

Watch point: US inflation data shows underlying price pressures remaining firm, which does justify hawkish policymakers’ views that Fed policy should move upwards.

EURO: The euro gained 0.13% to $1.1556 as July inflation data in the US lead traders to reduce near-term Fed rate hike expectations, narrowing the implicit year-end policy spread between the Fed and ECB in favor of the EUR. German inflation data out overnight confirmed that inflation rose to 2.8% YoY, up from 2.3% in June. Core inflation moved lower from 2.5% to 2.4%. On a monthly basis, consumer prices rose 0.8% in July, rebounding from a 0.3% fall in June and marking the fastest increase since March. Money market continue to favor upwards policy action from the ECB next month, pricing a 85% chance of a hike. ECB and Fed policy expectations will continue to play an outsized role in EUR price direction and fresh off today’s data favors the upside for the EUR in the near-term. Traders are pricing around 37 bps of further ECB tightening this year.

Watch point: Broader price direction will be subject to Fed-ECB policy expectations, which is likely to be favorable to the EUR in the near-term.

BRITISH POUND: Sterling is 0.21% higher at $1.3533, reaching a one-month high against the greenback following US inflation data. The main question for tomorrow’s Q2 GDP data is whether or not a slowdown in the economy will be enough to put the debate of BoE rate hikes to rest. June industrial production and trade data will also arrive alongside GDP, which should provide further detail on whether any weakness is concentrated in manufacturing/trade or more broadly based. Markets are less confident that the BoE will raise rates this year compared to the ECB. The BoE largely awaits further data to assess inflationary pressures and weigh a potential rate hike. Investors are pricing in 24 bps of tightening by year-end.

JAPANESE YEN: The yen gained 0.35% to 158.70 yen per dollar as today’s US inflation report has pushed back expectations of near-term rate hikes from the Fed. Recent support from US-Japan intervention has faded from reaching a three-month high of 155.20. This week is Japan’s Obon holiday period, leading to reduced market participation and lower liquidity, which could increase the risk of sharp market moves during thin trading activity. For the yen to jerk its weakening trend, a shift in fundamentals is needed as the country’s large debt overhang and Taikichi’s expansive fiscal policies, including her favoring a weaker yen, are structural problems that are unlikely to buck the trend. Market expectations of a September rate hike are priced at 60.6%.

Watch point: With the recent intervention in the currency, the yen will need strong monetary policy support from the Bank of Japan to prevent further depreciation.

AUSTRALIAN DOLLAR: The Aussie gained 0.40% to $0.7088. The Reserve Bank of Australia held rates and retained a hawkish bias saying it stands willing to raise rates if inflation pressures do not subside. The board noted inflation was too high, though noted that the economy was slowing as expected in the face of tighter policy. Investors are pricing an 17% chance of a hike in September. Markets imply around a 40% chance of a hike in November, from just over 50% ahead of the decision, and see 15 bps of tightening by year-end. The dovish element from the meeting came from the bank’s reference to falling house prices and weaker housing credit, which could potentially raise the bar for further tightening. Q3 inflation figures will serve an outsized role in determining whether or not the bank raises rates this year after second-quarter inflation came in below forecasts.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields moved lower across the curve in response to July’s inflation data, which came in line with expectations but did not reveal any substantial easing in underlying pressures. While July’s CPI print was disinflationary at the headline, underlying services inflation is still running near 3% YoY, while the backdrop of an unresolved Strait of Hormuz disruption leaves a material risk that the energy shock re-accelerates headline inflation and feeds into expectations. The energy index fell 1.5% in July, while gasoline declined 2.9% on a seasonally adjusted basis, providing the biggest direct offset to headline inflation. However, this is a monthly price-level correction, not a resolution of energy inflation: energy is still up 14.7% year over year and gasoline is up 24.6%. Thus, favorable July fuel prices suppressed the monthly CPI print. Shelter rose just 0.1% for a second consecutive month, contributing roughly two-thirds of the modest 0.1% headline gain. Rent and owners’ equivalent rent each rose 0.3%, which is firmer than the aggregate shelter figure. The difference is explained by a 2.8% decline in lodging away from home. Therefore, the headline shelter deceleration is welcome but likely overstates the improvement in persistent residential rent inflation.

Breakeven inflation remains well contained, suggesting that while underlying price pressures remain firm, markets continue to expect the Fed to ultimately bring inflation under control. That backdrop is supportive for bonds over the longer term and, so long as inflation expectations remain anchored, could help keep the 10-year yield below 4.70%. On the other hand, corporate earnings are rising at a pace that has historically been associated with higher 10-year Treasury yields, as earnings strength can indicate demand resilience and nominal growth that is inconsistent with rapid disinflation. This creates an important cross-market tension: strong earnings are supportive for equities, but they can also sustain higher long-term rates and limit the scope for Fed easing. SocGen’s equity market inflation proxy, based on developed market stocks most correlated with inflation has outperformed over the past year, potentially signaling a path of higher rates and inflation ahead.

Watch point: Mainly, the prospect that inflation will remain sticky reinforces a hawkish backdrop for the Fed over the medium-term, while Friday’s report has raised concerns that a slow labor market may be emerging.

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