Instant Insights: Sustainable progress on inflation? | Insight Investment

Headline and core consumer prices rose 0.2% in July, taking headline CPI from 3% to 2.9% and core CPI from 3.3% to 3.2%. Notably, the report continued to show disinflation across the “sticky” services sectors, indicating a potentially sustainable path toward the Fed’s 2% target. We believe this strengthens the case for the Federal Reserve (Fed) to initiate its rate-cutting cycle in September.

Energy and goods prices are down relative to a year ago

Core goods prices continued to display strong disinflation, down 0.3% month-on-month and 1.9% year-on-year.

Figure 1: Core services also continue to show signs of easing

Core services also continue to show signs of easing

Encouragingly, the "stickier" core services categories provided potential evidence of a sustainable trajectory toward the Fed’s 2% target.

The Fed closely monitors “supercore” services, which exclude housing categories, due to their potential sensitivity to labor market conditions. This measure declined from 4.7% to 4.5%, marking its lowest level since March 2024, with a notable easing in transportation services (Figure 2).

Figure 2: “Sticky” services categories continue to make slow, but steady, progress

The “shelter” category also continued to moderate, easing to 5.1%, its lowest since April 2022. We anticipate this trend will persist in the coming months, as the measure typically lags private rental indices. However, due to the calculation methodology of the rental components, we expect the decline to be gradual.

Consequently, we suspect the PCE index, the Fed’s preferred measure of inflation, will reach 2% before CPI. Shelter constitutes 36% of CPI by weight, but only 16% of PCE. The disproportionate influence of shelter inflation on CPI has been the primary driver of the growing divergence between the two inflation measures in recent years (Figure 3). Excluding shelter, headline CPI is running at 1.7% versus a year ago.

Figure 3: The “shelter” component of CPI may mean a slower convergence to 2% than the PCE measure

We think a rate cut in September remains a sensible base case

Inflation continues to steadily progress toward the Fed’s 2% objective, which we believe will give the Fed enough confidence to begin cutting rates at the next FOMC meeting.