Flicker of Heat in July CPI

The Consumer Price Index (CPI) edged up 0.3% in July from June and 1.8% from a year ago. That is still well below the Federal Reserve’s threshold for CPI, which tends to run a bit hotter than the Personal Consumption Expenditures (PCE) index it targets for monetary policy. A target of 2% on the PCE translates to a target of about 2.25% on the CPI.

Gains in the CPI were broad-based with the exception of natural gas and new vehicle prices, which declined during the month. Vehicle producers are offering more and more incentives to vehicles this late in the cycle. Car sales remain weak, while consumers continue their switch into SUVs. The gas mileage on those larger vehicles has improved quite substantially while gas prices remain relatively low. The best deals on new vehicles are on fuel-efficient economy cars, which are now accumulating on dealers’ lots.

Core (excluding food and energy) consumer prices rose 0.3% in July from June and edged up to a 2.2% increase from a year ago. Gains were broad-based with the exception of vehicles mentioned above. Airfares are up in part because of problems with Boeing’s 737 Max. (Several airliners have had to cancel flights with the jets parked in the desert until Boeing can fix a navigation problem associated with two crashes.) Airfares are likely to come down again when that inventory returns to the market.

The biggest problem in the consumer price index for most consumers is the cost of shelter, which remains elevated. Even low mortgage rates have not been enough to offset the surge in home prices we have seen in some of the hottest markets.

Separately, higher tariffs announced for June 1 on China are beginning to work their way through the supply chain. Most are showing up as a squeeze on margins and starting to put a damper on hiring in the worst affected sectors. The next tranche of tariffs, which will show up as increases in consumer prices, is slated to start on September 1. The president has ordered 10% tariffs on the remaining $300 billion in imports coming in from China. These include a broad spectrum of consumer goods. Retailers with razor-thin margins will have little choice but to pass the costs onto consumers. Big-box discounters are particularly vulnerable. The only offset for consumers could be lower prices at the gas pump.

In addition, Hong Kong airport is a hub for cargo flights. Delays there in response to a sit-in at the airport, which has caused a flurry of cancellations, could show up in prices as soon as September. Retailers were attempting to stock up ahead of the president’s most recent round of tariffs.

Bottom Line
Inflation ticked up slightly in July, but not enough to stop the Fed from cutting rates again in September. Increases due to tariffs will erode instead of boosting consumer spending, which will unfortunately provide more reason for the Fed to cut as we enter the holiday season. Gifts could become expensive this year.

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