The July CPI report was good news for Fed officials and the rest of us. Inflation is moving closer to the Fed's 2.0% target. However, the inflation picture may not be as bright as the CPI report suggests.
New York Fed President John Williams recently said that if core PCED inflation readings remain above 0.2% m/m during the second half of this year, then the Fed should tighten monetary policy. The Cleveland Fed's Inflation Nowcasting model continues to estimate a 0.25% m/m increase in core PCED inflation for July and 0.27% for August. The Fed gives more weight to the core PCED than the core CPI in setting monetary policy.
That helps explain why the 2-year US Treasury yield remains roughly 75 basis points above the federal funds rate, suggesting that fixed-income markets continue to expect a Fed rate hike in the coming months (chart). The 10-year Treasury yield also remained elevated, at 4.68%, after the CPI report.
Nevertheless, the July CPI report was broadly a good one. So the odds of a Fed rate hike at the September meeting declined on the news. Consider the following:
