All eyes are on Washington this week as the latest US inflation figures are set to land. The big question: did the pace of consumer price increases keep cooling in July, as analysts expect, or did volatile oil prices keep the heat on?
The stakes are high for everyday investors because inflation is the single biggest driver of what the Federal Reserve does with interest rates, and rates, in turn, move the stock and bond markets.
What the numbers are expected to show
In June, the annual rate of US inflation fell to 3.5% – the first decline in five months and below the 3.8% that forecasters had predicted. That was a welcome sign that the worst of the price surge was behind us.
For July, economists expect the headline rate to ease a touch further, to around 3.4%. The so-called core rate – which strips out volatile food and energy prices – is projected to dip to 2.5%, down from 2.6%.
But here's the catch: the broad inflation number, known as the consumer price index (CPI), is built from more than 200 categories, which are placed into eight major groups. Housing costs are the heaviest weight in the basket, and they've been sticky. So even if the headline number looks good, the underlying picture can be messier.
Why the Fed is looking elsewhere
While CPI gets the headlines, the Federal Reserve doesn't actually target it. The central bank's preferred inflation gauge is the personal consumption expenditures (PCE) price index, which is calculated differently and has tended to run a bit cooler than CPI.
That difference matters. If the PCE measure shows inflation closer to the Fed's 2% goal, policymakers may feel less pressure to keep interest rates high. That could be good news for stocks, because lower rates tend to boost corporate profits and make future earnings more valuable today.
But it also means the CPI report might not tell the whole story. Investors who only glance at the headline number could be misled about the true state of inflation – and about what the Fed is likely to do next.
Oil prices muddy the picture
One wildcard is energy. Crude oil prices have been volatile recently, and that volatility can swing the headline CPI number even when the underlying trend is calm. If oil spiked in July, it could keep the headline rate hotter than expected, even if core inflation is cooling.
That's why analysts and the Fed pay so much attention to the core rate – it gives a clearer read on the underlying demand pressures in the economy. For investors, a core reading that comes in at or below expectations would be a reassuring sign.
What it means for your money
For everyday investors, this week's data is more than just a number. It's a signal about the path of interest rates.
If inflation continues to cool, the Fed may be able to start cutting rates later this year or in early 2025. Lower rates would likely be a tailwind for stocks, especially growth and technology shares, and could also ease pressure on bonds. On the other hand, if inflation stays hot, the Fed could keep rates higher for longer, which tends to weigh on stock valuations and increase borrowing costs for consumers and businesses.
It's also worth remembering that markets have already priced in a lot of good news. If the CPI comes in exactly as expected, the reaction might be muted. The real fireworks could come if the number surprises to the upside or downside.
The bigger picture
Inflation has come a long way from the double-digit highs of 2022, but the last mile back to the Fed's 2% target has been bumpy. Housing costs remain elevated, and services prices – from car repairs to restaurant meals – have been slow to cool.
At the same time, the job market has shown signs of softening, which could give the Fed cover to ease policy. A weaker jobs report earlier this month already stirred expectations of a rate cut. You can read more about what to watch in the jobs data and how it affects the dollar.
For investors, the key takeaway is to stay diversified and not overreact to any single data point. Inflation reports are important, but they're just one piece of the puzzle. The Fed will weigh a range of indicators – including jobs, wages, and consumer spending – before making its next move.
As always, keep an eye on the core number, watch oil prices, and remember that the Fed's preferred gauge may tell a different story than the headline CPI. That's the nuance that can make all the difference for your portfolio.
