For the first time in three years, the US CPI is below 3%, it's time to worry about other things

As the US July inflation rate falls below 3%, market focus shifts to other risk factors.

The overnight release of the July CPI showed a year-on-year growth rate dropping below 3% for the first time since 2021, falling within the official target range set by the Federal Reserve. This means that the long-standing issue that has been troubling the Federal Reserve has finally reached a key turning point, further supporting expectations of a rate cut by the Federal Reserve in September.

As the market gradually believes that inflation will steadily decline to the 2% target, where else might risks still exist?

Housing Inflation Risks Remain

Looking into the July CPI, thanks to the moderation in fuel and food prices, goods inflation has dropped into negative territory, while service inflation remains the biggest driver of inflation.

Housing, as a sub-item in service inflation, accounts for about two-thirds of core services. CPI data shows that in July, housing inflation increased by 0.33% month-on-month and 5.05% year-on-year; the super core CPI (excluding housing from core service CPI) rose by 0.2% month-on-month, but the year-on-year increase fell to 4.73%.

Bloomberg columnist John Authers commented that the more serious concerns come from the real estate market, although one month of data is not enough to make a judgment, this data does weaken the market's optimistic expectations of a steady decline in inflation.

However, due to the different coverage and calculation methods of CPI rent and market rent, market rent often leads CPI rent, meaning that changes in private sector rent can more timely reflect market trends.

The current private sector rent index shows that rent inflation has already fallen from its peak a year ago and stabilized. Omair Sharif of Inflation Insights LLC pointed out that official statistics on housing inflation usually do not decline rapidly.

This also means that the actual level of rent prices may be lower than the official rent level. Authers also added that the Federal Reserve has more data sources and is unlikely to rely entirely on official data to make monetary policy decisions.

In Authers' view, the overall data for July CPI still supports expectations of a rate cut by the Federal Reserve in September, but not to the extent of "aggressively cutting rates," with the expected rate cut not exceeding 25 basis points.

Brian Rose, an economist at UBS Global Wealth Management, believes that the decision to cut rates by 50 basis points will depend on the August non-farm payroll report released on September 6.

Watch for Soaring Oil Prices, Kishida's Withdrawal

With escalating geopolitical uncertainties, there is a risk of short-term surges in oil prices, which could have a huge impact on the US economy and society.

Brent crude oil rose by 7.8% last week, marking the largest weekly gain since April last year. Authers pointed out that considering the current oil prices are below the average level of the past twenty years, if oil prices continue to surge sharply, it will have a significant impact However, currently, US oil prices are relatively stable.

Another event worth noting is the news that Japanese Prime Minister Fumio Kishida will no longer seek re-election.

Considering that arbitrage trades involving the Japanese yen have been unwinding on a large scale in recent weeks, any news from Japan could shake the market.

The impact of Kishida's withdrawal on the market, according to Auther, largely depends on who will become the new leader, which will gradually become apparent in the coming months.

Popular candidates for the next president of the Liberal Democratic Party include former Secretary-General Shigeru Ishiba, Minister of Digital Transformation Taro Kono, prominent party member Toshimitsu Motegi, and Minister of Economic Security Sanae Takaichi.

Among them, the first three advocate for a tightening policy to support the yen, while Sanae Takaichi is a staunch supporter of Abenomics, which may imply that Kishida's withdrawal is likely to lead to fiscal and monetary tightening, potentially causing a significant downturn in risk assets.

Auther suggests that with the strong expectation of a rate cut by the Federal Reserve in September, the Bank of Japan is likely to temporarily maintain its policy interest rate level