Image Source: Pixabay

Yesterday, July 15, 2025, the Bureau of Labor Statistics released its July inflation report, which is intended to provide the capital markets and American citizens with information about changes in the general price level of consumer products during the month of June 2025. On the surface, the numbers appeared respectable. From the report:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent on a seasonally adjusted basis in June, after rising 0.1 percent in May, the U.S. Bureau of Labor Statistics Reported today. Over the last 12 months, the all items index increased 2.7 percent before seasonal adjustment.

The month-over-month figure was in-line with what economists expected, but the year-over-year figure (which came in at 2.7%) was higher than the 2.6% rate that economists and analysts predicted. This also represents an acceleration over the previous month, such that we have now had three straight months of a rising inflation rate:

Source: Trading Economics

This is almost certainly not what the Federal Reserve wanted to see, but it is consistent with the general trend that started occurring following the central bank’s interest rate cut back in September of 2024. As regular readers know, I have been rather critical about the interest rate cuts, and I very much disagree with all of the financial commentators and Federal Reserve governors who have been making the claim that current monetary policy is “restrictive.”

The Federal Reserve Bank of Chicago regularly publishes an index called the “Chicago Fed’s National Financial Conditions Index” that ostensibly shows investors whether financial conditions are loose or tight. According to the Federal Reserve:

The Chicago Fed’s National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional and “shadow” banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.

Over the past five years, this index has been consistently negative:

Source: Federal Reserve Bank of St. Louis

As we can see, the only time in the past five years that conditions came anywhere close to being more restrictive than average was right at the end of 2022. Basically, it appears that the initial round of interest rate hikes in 2022 did have the desired effect of making conditions tighter, but they still remained looser than the long-term average tightness in the market. Furthermore, since the middle of October 2022, financial conditions have generally been loosening. Thus, financial conditions are currently far from being “restrictive” as the Federal Reserve’s leadership likes to claim, and that has been the case throughout the entire interest rate hiking cycle. As of right now, the Chicago Fed’s National Financial Conditions Index is at -0.54351, which actually puts it at a very similar level to late 2020 when interest rates were 0%. Thus, if the Federal Reserve’s intention was to hike interest rates sufficiently as to make conditions truly tight and beat inflation, it appears to have surrendered before accomplishing its goal.

In addition to this, the Taylor Rule was consistently stating throughout much of 2022 that the Federal Reserve would not beat inflation until the federal funds rate was close to 10%. Several years ago, former Federal Reserve Chairman Ben Bernanke provided an alternative formula that is intended to help the Federal Reserve arrive at an appropriate policy rate. It likewise was providing very similar figures (between 7.25% and 10%). Obviously, the Federal Reserve never raised interest rates anywhere close to that extent as it stopped at a federal funds target range of 5.25% to 5.50%. The Federal Reserve was also consistently promising to reduce rates throughout the entire rate-hiking cycle, which caused the capital markets to keep conditions looser than they otherwise would have been. Overall, the Federal Reserve never achieved the so-called restrictive conditions that they wanted. All that the interest rate hikes managed to accomplish is to tighten conditions somewhat compared to the ultra-loose environment in early 2021.

As such, inflation was never actually beaten. At this point, there may be some readers who point out that the year-over-year rate of change in the Consumer Price Index was declining over the course of the first few months of this year. While that is correct, it was largely due to crude oil prices declining. If we look at the spot price of West Texas Intermediate crude oil over the period from December 31, 2024, through May 31, 2025, we see this:

Source: Barchart

As shown, crude oil prices declined 15.31% over the first five months of the year. The price of crude oil accounts for a significant proportion of the Consumer Price Index for All Urban Consumers, so a decline here would reduce the inflation rate even if the price of everything else is staying stable or rising. There is, in fact, an alternative Consumer Price Index for All Urban Consumers that excludes the price of food and energy. This is called the Core Consumer Price Index, and it consistently put inflation at 2.80% annualized or higher in every month this year:

Source: Trading Economics

While we do still see improvements during the first three months of this year, we still see that this measure of inflation does not show a whole lot of improvement. After all, the Core Consumer Price Index posted a 2.8% annualized figure at its lowest point, which is well above the Federal Reserve’s 2% target. It appears that even this metric has begun to reaccelerate, primarily due to core goods, which posted its first increase since December of 2023.

Inflation has been consistently higher that even the reported core figure shown above in certain segments of the economy. The latest inflation report shows Owners’ Equivalent Rent rising at 4.2% year-over-year. In other words, shelter prices are still rising at a very rapid pace (more than double the Federal Reserve’s target level). In addition, the so-called SuperCore Consumer Price Index (core services excluding shelter) came in at 3.02% for June, or more than 50% higher than the Federal Reserve’s 2% target:

Source: Zero Hedge

In other words, this was a terrible inflation report and it certainly does not bode well for those who were expecting the Federal Reserve to continue reducing interest rates later this year. That is what the market as a whole expects, with the bond market currently pricing in two 25-basis point cuts to the federal funds target rate by the end of the year:

Source: Chicago Mercantile Exchange

The data, however, seems to suggest that even the rate cuts last year were a mistake. In order for inflation to hit the Federal Reserve’s target level in 2025, the United States would have to experience deflation in every category for the remainder of the year. This means that housing prices will have to decline, crude oil will decline, food will decline, and almost certainly the S&P 500 Index would have to fall substantially. After all, there is very little possibility of this scenario occurring outside of a recession that is at least as bad as the one that followed the subprime mortgage collapse in 2009. In the absence of such a recession, though, it is very difficult to see how the Federal Reserve could possibly justify further interest rate cuts.

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