While we've been focused on stocks, AI, and corporate earnings, there has been one question running quietly in the background that literally influences everything: What is inflation doing, and what will the Fed do next?
Yesterday, the United States released its latest inflation report, the famous CPI. The numbers came in exactly as expected. That may sound boring, but right now, boring is the best possible outcome the market could have hoped for.
Headline inflation rose by 0.1% in July compared to June. On an annual basis, inflation came in at 3.4%, down from 3.5% the previous month.
Now let's look at the figure the Fed really pays attention to: Core CPI.
Core CPI excludes food and energy prices. Why? Because those two categories can swing wildly from month to month and often distort the broader picture.
Core CPI increased by 0.2% month over month and reached 2.5% year over year, down from 2.6% in June. More importantly, this marks the slowest annual Core CPI reading since March 2021.
Everything came in exactly in line with analysts' expectations.
There is, however, one major caveat. At 2.5%, Core CPI remains above the Fed's 2% target. So yes, inflation is moving in the right direction, but the job is not finished yet.
This is where things get more interesting.
The headline number tells us very little. The breakdown tells us everything.
Housing costs increased by only 0.1%, but because housing is such a large component of the index, it accounted for roughly two-thirds of the monthly increase. Rents rose 0.3%, while hotel prices fell 3.3%, their biggest decline in a year.
Energy prices fell 1.5% during the month, which is good news. But on a year-over-year basis, energy prices remain up 14.7%.
The reason is simple. The conflict involving Iran continues, gasoline prices moved back above $4 per gallon during July after the ceasefire collapsed, but the average price for the month still ended up lower than in June.
For the first time since March, grocery prices declined.
In services, medical care rose 0.4%, airline fares increased 2.2%, and education costs climbed 0.5%.
Perhaps the most surprising figure was technology. Computer software and accessories surged 21.2% over the past year, while computer prices recorded their largest increase in four years.
Why are computers getting more expensive?
Because there is a global shortage of memory chips. And that shortage exists because the entire world is building AI data centers at an unprecedented pace. Apple, for example, already raised prices on Macs and iPads in June.
In other words, the AI boom is now starting to influence inflation itself.
This is where the Fed enters the picture.
The debate is no longer about whether rates will be cut. The question now is whether they might need to be raised again.
Following the inflation report, the probability that interest rates remain at 3.5% to 3.75% rose to 62%, up from 52% on Tuesday. On prediction market Kalshi, traders are assigning roughly a 67% probability to rates staying unchanged, while the odds of a hike have fallen to around 33%.
So, is the issue settled?
Not even close.
The Fed focuses more heavily on Core PCE, not CPI. And Core PCE stood at 3.3% in June, significantly higher than Core CPI.
As Fitch economist Olu Sonola put it:
"Two consecutive favorable CPI reports would normally calm concerns. But with core PCE at 3.3%, the outlook remains uncomfortably uncertain."
David Kelly of JPMorgan offered perhaps the most memorable quote of the day:
"America has Teflon inflation. It doesn't stick."
His argument rests on three factors.
First, the impact of tariffs will appear smaller in annual comparisons.
Second, oil prices are easing as optimism grows about a possible end to the conflict.
Third, and most importantly, wage growth is now running consistently below inflation.
Indeed, real average wages fell 0.2% year over year in July.
Markets responded positively.
The S&P 500 gained 0.3%, while the Nasdaq 100 rose nearly 1%, recovering part of the week's losses.
Bond yields also declined as investors reduced their bets on a September rate hike.
Meanwhile, market strategist Ed Yardeni raised his year-end 2026 target for the S&P 500 to 8,400 points.
He also made an observation worth remembering:
"We believe any correction will be a buying opportunity and will not trigger a recession or a bear market similar to 1999-2000."
In short, inflation continues to cool, the Fed is getting closer to its target, and markets are increasingly confident that rates will stay unchanged. However, with Core PCE still elevated and wage growth weakening, the battle against inflation is not over yet.
