Benign July Inflation Data?

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 are modestly higher, as traders digest July’s PPI report alongside a drop in oil prices. July’s PPI headline was benign, final demand was unchanged after a 0.1% decline in June, but the underlying composition was firmer. Energy-driven goods deflation masked a renewed acceleration in core services and a late-stage pipeline pickup, leaving the report more inflationary beneath the headline than the 0.0% print suggests. This is a similar tale to yesterday’s data, which saw headline CPI rise 0.1%, core rose 0.2% in July, both matched consensus forecasts, though underlying inflationary pressures continued to mount. Services-ex energy gained 0.2% MoM to land at 3.0% YoY, suggesting that the overall profile of inflation remaining sticky, and a reading that will support the hawks camp. Cleveland Fed President Beth Hammack and Richmond Fed President Thomas Barkin speak later today. Markets will focus on whether they validate the recent shift toward a September hold or keep a hike firmly in play.

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 slipped to 99.84 following July’s PPI data, which revealed firm underlying cost pressures. The headline was held down by a 3.1% fall in final-demand energy prices and a 0.9% drop in food prices. Gasoline alone fell 5.7% and accounted for more than half of the monthly decline in final-demand goods. In contrast, goods excluding food and energy still rose 0.1%; motor vehicles and equipment increased 0.3%. While July’s inflation data saw traders push back expectations of a September rate hike, the reports reveal that underlying inflationary pressures remained firm, which is likely to reinforce hawkish Fed members views that policy should move upwards. As such, and given the lack of forward guidance from the Fed, a September rate hike remains firmly on the table. Meanwhile, ongoing uncertainty over US-Iran negotiations and Brent prices near $90bbl are likely to keep the dollar will bid.

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 0.1% to $1.1533 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. Industrial production in the eurozone was unchanged in June, though beat forecasts of a 0.1% decrease. Durable consumer goods saw a rebound in production (0.3% vs -1.3%) alongside further growth in non-durable goods (3% vs 3.3%).Among the bloc’s largest economies, industrial production rose 0.2% in Germany, was unchanged in France and declined 0.7% in Spain. YoY, industrial production increased 0.1%, beating expectations of a 0.8% decline. Money market continue to favor upwards policy action from the ECB next month, pricing a 90% 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 little changed at $1.3498, following a slate of GDP and industrial production data. UK growth outperformed expectations in June and Q2, driven by services, but the details still point to a softer second half as energy costs, fiscal uncertainty, and the renewed Iran-war disruption weigh on activity. Monthly GDP rose 0.3% in June, against consensus for no growth, after flat growth in May and a 0.1% contraction in April. Q2 GDP grew 0.4% QoQ, slowing from 0.6% in Q1 but matching consensus and remaining relatively firm by recent UK standards. June was services-led: services output rose 0.4%, only partly offset by a 0.2% fall in industrial production and a 0.1% decline in construction. The Bank of England had expected Q2 growth of 0.3%, but estimates underlying growth at only around 0.1% and expects growth to slow toward zero in Q3 as the energy shock, higher operating costs, and weak external backdrop weigh on demand. While headline GDP is stronger-than-expected, it does not materially remove the case for a cautious BoE given the temporary nature of June’s supports. Markets have shored up bets of tightening from the Bank of England in response though, now pricing in 27 bps of tightening by year-end, up from 24 bps ahead of the reports.

JAPANESE YEN: The yen gained 0.15% to 159.17 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 is little changed at $0.7062. Reserve Bank of Australia Assistant Governor Christopher Kent emphasized that inflation and rates were biased to the upside. The RBA 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. Several banks are now expecting the central bank to remain on hold throughout the rest of the year, having already hiked three times this year. Investors are pricing an 16% chance of a hike in September. Markets imply around a 44% chance of a hike in December, and see 13 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 painted a similar tale to the CPI data released yesterday: weaker headline figure masking underlying pressures. PPI excluding food, energy, and trade services rose 0.4% following a 0.1% rise in June. At that pace, the measure’s three-month compounded annualized rate over May–July is about 5.3%, while its 12-month rate was also 4.7%. That is not consistent with a broad-based, clean disinflation trend in producer-level core prices. CPI 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. For rates, the reports are modestly dovish, as they supports the view that the energy-driven goods shock is unwinding/can unwind fast, but underlying inflation signals are still flashing, arguing against any near-term disinflation. For Fed policy, without any forward guidance, the September decision will likely remain a close call.

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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