US inflation preview: Headline to ease, core to pick up, 75 bp rate hike still on the table

Nervous investors await what is widely expected to be an inflection point for US inflation, forecast to soften to an annual rate of 8.7% in July from 9.1% in June.

Plateauing consumer prices alongside a ‘technical recession’ has supported the view that the Fed will need to pivot out of its aggressive tightening stance, which has supported equity market valuations in the past few weeks.

Still, it might be too soon to call victory over stubbornly high prices, with core inflation - which removes volatile food and energy categories - expected to rise to an annual rate of 6.1% from 5.9% in June as falling durable goods prices are offset by rising rents. 

Energy to ease, rents to rising

US gasoline prices have decelerated rather quickly, from June peaks of around US$5 a gallon to around US$4.05 in early August.

Alongside sliding commodity prices, this is expected to ease the headline rate.

Crude oil vs. US inflation (Source: TradingView)

That said, US rents have continued to rise for all of 2022, up 12% year-on-year in July, according to Compound Capital.

Even if headline inflation is easing thanks to lower energy prices, factors like food, rent and wages are still trending higher.

What's perhaps worse for the 'we have defeated inflation' narrative is that shelter makes up 33% of US CPI, while transportation fuel just 8%.

History doesn’t look good

If history were to repeat itself, the S&P 500 would fall sharply on Wednesday.

The S&P 500 has slipped on every inflation print this year, except January, which was the only print that was in-line with expectations.

On average, the S&P 500 declined -1.04%.

Looming leg lower

"The rally in stocks has been powerful, and has many investors believing the bear market is over. However, we think it's premature to sound the all-clear simply because inflation has peaked," said Morgan Stanley's US Chief Investment Officer, Mike Wilson.

"The next leg lower may have to wait until September when our negative operating leverage thesis is more reflected in earnings estimates. However, with valuations this stretched, we think the beset part of the rally is over."

Fed still poised to hike

The Fed is expected to continue aggressively hiking interest rates amid stubborn core inflation and an unexpectedly strong US jobs report last Friday.

Currently, the likelihood of another 75 bps rate hike for the Fed's September meeting stands at 66.5%, according to CME Group.