In July, the core inflation in the United States reached a five-year low, alleviating concerns about interest rate hikes by the Federal Reserve. However, the escalation of oil prices and shrinking wages are brewing the next storm.

Data released by the U.S. Department of Labor on Wednesday indicated that the Consumer Price Index (CPI) showed a moderate performance in July, with the core inflation rate falling to its lowest level in over five years, which somewhat alleviated the urgency for the Federal Reserve to raise interest rates in the September meeting. However, it is noteworthy that the wage data released around the same time revealed a continued decline in the actual purchasing power of workers. Coupled with recurring conflicts involving GEO Group Inc. in the Middle East pushing energy prices higher, the inflation outlook in the U.S. remains full of uncertainties. Specifically, the CPI increased by 0.1% month-on-month in July, rebounding from a decrease of 0.4% in June (the first monthly decline in six years); the year-on-year increase slightly slowed to 3.4%, down from 3.5% in June. Excluding the volatile food and energy prices, the core CPI rose by 0.2% month-on-month, rebounding from a flat reading in June; year-on-year, it increased by 2.5%, which was not only lower than June's 2.6% but also matched the lowest growth rate since March 2021. Both figures are consistent with the median expectations of economists. In terms of weight impact, housing costs remain the primary driver of rising prices for the month. The housing price index increased by 0.1% month-on-month in July, contributing nearly two-thirds of the overall price increase. Food prices saw a slight overall increase of 0.1%, but there were significant internal disparities: the dining-out index rose by 0.3%, while household food prices experienced a decrease for the first time since March. Notably, due to a cyclospora outbreak, lettuce prices recorded their largest historical drop, significantly contributing to the food price decline. In other areas, energy prices displayed a notable contradictory trend in July. Gasoline prices fell by 2.9% month-on-month, and electricity prices were nearly flat with a marginal increase of 0.1%, helping to suppress the overall inflation reading. However, this decline may only be a reflection of past circumstances. In July, the ceasefire agreement between the U.S. and Iran had already collapsed, rekindling hostilities and pushing average gasoline prices across the U.S. to surpass $4 per gallon again, although the monthly average remained lower than in June. Entering August, the upward trend in the energy market became even more apparent. On the day the CPI report was released, Brent crude oil futures reached $90 per barrel, while U.S. WTI crude drew near $84. Economists warn that even though the U.S., as a net oil exporter, has somewhat mitigated the price shock from Middle Eastern conflicts by releasing strategic petroleum reserves, this buffer is unlikely to last indefinitely. In the future, the U.S. and other countries will have to replenish their oil inventories, which could keep oil prices elevated for an extended period, thereby boosting energy costs for consumers in subsequent months. In the commodity sector, core commodity prices excluding food and energy rebounded in July after two months of decline. Particularly notable was an exceptional spike in the prices of computers and related products. The prices of computer software and accessories surged by 21.2% year-on-year, marking the largest increase on record; the price increases for computers, peripherals, and smart home assistants also reached their highest in over four years. Economists attribute this to a global surge in data center construction leading to a widespread shortage of memory chips, with the impacts of price increases announced in June by popular consumer tech products like Apple Inc. (AAPL.US) Mac computers and iPads now reflected in the data. In terms of service prices, the sub-index excluding energy and rent saw a slight month-on-month increase of 0.2%, reversing the downward trend from the previous month. Prices for categories such as airfare, healthcare, communications, education, and entertainment all rose in July. However, motor vehicle insurance prices were one of the few major indices to decline during the month. Federal Reserve Policy Outlook: A Standoff Between Hawks and Doves This mild inflation report, together with the earlier unexpectedly weak employment data, significantly influenced market pricing of monetary policy pathways. Following the report's release, U.S. stock index futures rose, and U.S. Treasury yields fell as investors notably reduced their bets on a rate hike by the Federal Reserve during its meeting scheduled for September 15-16. According to CME Group Inc. Class A's "FedWatch" tool, the market-implied probability of a rate hike in September was around 46% prior to the data release, and it further dropped to 36% after the CPI announcement. Currently, the Federal Reserve's benchmark interest rate is maintained in the range of 3.50% to 3.75%. Since the U.S. initiated military actions against Iran, the Federal Reserve has kept rates unchanged, even as major central banks in Europe and Japan began hiking rates. Federal Reserve Chairman Kevin Warsh is expected to speak later this month at the annual Jackson Hole symposium, and investors plan to scrutinize his remarks for policy signals. Moreover, ahead of the September rate-setting meeting, policymakers will also be examining employment and inflation reports for August. However, there are dissenting voices within the Federal Reserve. Cleveland Federal Reserve Bank President Loretta Mester candidly called for action on social media on Tuesday. Now is the time to act, she wrote, the longer we wait to pull inflation back to the 2% target, the harder the task of reining in inflation will become, and the greater the cost to the American people. This hawkish stance contrasts with some colleagues who believe there needs to be a further weighing of inflation against the risks of employment slowdown, leaving the final decision for the September meeting uncertain. Additionally, it's worth noting that statistical methodologies for measuring various price indices are about to be adjusted. The U.S. Department of Commerces Bureau of Economic Analysis will implement changes in the computation methods for the Personal Consumption Expenditures (PCE) price index that involves categories such as legal services, computer software, and investment consulting in September. The Federal Reserve prefers inflation indicators based on PCE, and year-to-date, the increases in the core PCE have generally outpaced those of the core CPI. Shrinking Real Wages Hurt Consumer Confidence Although the July CPI data suggests a surface-level deceleration, this report still offers little real comfort to the average American consumer. A separate report released the same day by the U.S. Department of Labor showed that price increases continue to outpace wage growth; after adjusting for inflation, the real average hourly wage decreased by 0.2% year-on-year in July. Since the onset of the conflict in Iran, this measure of residents' actual purchasing power has continued a series of weak readings. In July, the year-on-year growth rate of the unadjusted average hourly wage was 3.2%, significantly lagging behind the 3.4% increase in consumer prices. The steep cost of living is genuinely eroding the public's satisfaction with the economic situation. This discontent is already reflecting in the political arena and may affect the Republican Party's prospects of regaining control of Congress in the upcoming midterm elections in November. Former President Donald Trump had won the 2024 election by pledging to reduce inflation, but now he faces increasing pressure from voters whose real incomes continue to shrink. In an interview released Monday night, Trump accused Iran of being a cunning negotiator and outlined his current options for dealing with the conflictwaiting for Irans economy to collapse or implementing very, very severe measures against Iran. The direction of the war, linked to oil prices, constitutes a key uncertainty affecting the U.S. economy and political agenda in the coming months.