In July 2025, the US Consumer Price Index (CPI) recorded a year-on-year increase of 2.7%, slightly below the expected 2.8%. The core CPI, excluding food and energy, rose by 3.1% year-on-year, slightly above the anticipated 3.0%. The month-on-month CPI matched expectations at 0.2%, with an unrounded figure of 0.197%. The core CPI for the month stood at 0.3%, or 0.322% unrounded, aligning with expectations. Real weekly earnings increased by 0.4%, following a previous decline of 0.3%.

Notable increases in certain categories included a rise in coffee prices by 2.3% and furniture & bedding by 0.9%. Used cars & trucks saw a 0.5% price increase, a shift from the prior month’s 0.7% decline. However, there were decreases, with motor fuel dropping by 2.0% and fresh fruits declining by 1.4%.

Stock Market Reaction

The stock market responded positively, with the Dow increasing by approximately 200 points, the NASDAQ rising by 120, and the S&P gaining 43 points. In yields, the two-year dropped by 3 basis points to 3.716%, and the ten-year decreased slightly by 1.1 basis points to 4.261%. Rate expectations suggested a 90% probability of a cut in September, adjusting from an 85% likelihood before the report. There are projections for 60 basis points of rate cuts by year-end.

Based on today’s July inflation report from August 12, 2025, the initial market reaction seems overly optimistic. While the headline number cooled slightly, we are seeing the core year-over-year inflation tick up to 3.1%, beating expectations. This stickiness, driven by a 0.4% monthly jump in services, is precisely what the Federal Reserve has been worried about.

This situation feels similar to what we saw in the first half of 2024, when persistent services inflation delayed the Fed’s pivot. The strong 0.4% rise in real weekly earnings will only add to the Fed’s concern that consumer demand is too strong to guarantee a smooth return to their 2% target. We must therefore be cautious about the market’s aggressive pricing of rate cuts.

For derivative traders, the drop in the 2-year yield to 3.71% looks like an opportunity to position for a potential reversal. The market is now pricing in a 90% chance of a September cut, but this mixed data gives Fed officials plenty of reason to push back against that narrative at the upcoming Jackson Hole symposium in late August. Buying options that profit from a rise in short-term rates could be a prudent hedge against a hawkish surprise.

Equity Market Concerns

In the equity markets, the rally in the S&P 500 and NASDAQ is running on the assumption of cheaper money, but this foundation seems shaky. The CBOE Volatility Index (VIX) has likely fallen on this news, currently trading near a relatively low 14, suggesting complacency among stock investors. This environment is ideal for purchasing protective put options on major indices at a cheaper price to guard against a market downturn.

Looking at the details, the weakness in categories like motor fuel and appliances should be noted. This could signal developing softness in consumer spending on certain goods, potentially impacting the outlook for related retail stocks. Conversely, the surprising strength in used cars and tools might be an early sign of tariffs rippling through the economy, a factor that could complicate the inflation picture in the months ahead.

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