US Inflation Slows Further, But the Bond Market Doesn't Buy It

Huitong Network, August 13—— Until the bond market is convinced—the worst phase of war-related inflation threats has passed and a slowdown in inflation is the path of least resistance—the prospect of further Fed rate hikes will remain highly uncertain. Although yesterday's CPI data looks encouraging (even if only marginally improved), the Fed does not operate in a vacuum and will still face a tug-of-war with bond yields when formulating monetary policy.

Consumer inflation eased in July, providing the Fed with a new round of supportive data to remain patient on rate hike decisions. The bond market is still skeptical, but yesterday's released Consumer Price Index (CPI) for last month, along with other alternative CPI benchmark readings, all suggest that even if price pressures have not eased significantly, they are at least stabilizing. Looking ahead to the next data update, both sets of August CPI nowcasts point to a continued slowdown in inflation this month.



The main risk factor (still) is Iran, but if the conflict remains relatively calm, the foundation for a weakening price trend seems to be in place.

Let's first look at the rolling one-year standard CPI data. Both headline and core CPI eased in July, indicating the war-driven inflation spike has peaked. Notably, the core CPI continues to slow, with year-on-year growth down to 2.5%, which is in line with the pre-war January trend and already close to the Fed’s 2% target.




Three alternative CPI indicators published by the Cleveland Fed and Atlanta Fed aim to minimize noise and highlight inflation signals, and these indicators also show a continued easing of inflation up through July.





The one-year trend in wages also points to easing inflation. Combined with recent weak job growth in the private non-farm sector, this set of data suggests the labor market’s impact on short-term inflation is diminishing.





The Cleveland Fed’s CPI nowcast model shows inflation will continue slowing in the next data update.



The Capital Spectator’s core CPI nowcast model also indicates inflation will continue to slow in the short term. In recent months, this model has generally been accurate in terms of forecast direction. The August outlook corroborates the Cleveland Fed’s nowcast, further reinforcing expectations that inflationary pressure will continue to ease.





Another proprietary model run by the Capital Spectator also points to weakening inflationary pressures after the initial spike at the onset of this war round. The Inflation Pulse Index aggregates the 12-month percentage changes of all 32 components of CPI and scores each metric. The total score—the Inflation Pulse Index—reflects the overall bias of inflation, with a reading range from 0 (strong deflation/disinflation bias) to 1.0 (strong inflation bias).





Several factors to be alert to could spoil this “disinflation party.” In addition to uncertainty around Middle East conflicts, the bond market remains skeptical that inflation risks are truly easing. For example, the US 10-year Treasury yield rose to 4.70% yesterday, trading near the highest levels since early 2025.





Until the bond market is convinced—the worst phase of war-related inflation threats has passed and a slowdown in inflation is the path of least resistance—the prospect of Fed rate hikes will remain highly uncertain. Although yesterday's CPI data looks encouraging (even if only marginally improved), the Fed does not operate in a vacuum and will still grapple with bond yields when formulating monetary policy.