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Investors breathed a sigh of relief.

The Consumer Price Index (CPI) for July showed consumer inflation rising at a 2.7% pace compared to last year. That’s in line with last month’s increase and matched economist estimates. Investors cheered that inflation didn’t come in even worse.

That’s because the effective tariff rate currently stands at 18.6%. That’s the highest level since 1933. Recent reports have shown that tariffs are fueling price increases in certain categories, like home goods.

Yet it seems overall inflation is holding steady. That news sent the S&P 500 to a fresh record high.

That said, the inflation news isn’t as good as you think. And one critical sector is creating cause for concern…

Core Inflation Is Running Hot

Headline inflation looked to be in line with estimates, but core inflation is moving in the wrong direction.

Core inflation strips out food and energy prices because those categories tend to be more volatile. The core CPI came in at 3.1% in July – a bit higher than expected.

The rate of change recently crept higher again as well. You can see that in the chart below:

That means core inflation is climbing even higher above the Federal Reserve’s 2% inflation target.

And leading indicators suggest that more inflation increases are in store.

Back in 2022, Fed Chair Jerome Powell discussed an inflation measure called “supercore” inflation. It looks at services inflation excluding housing costs. Powell said that supercore is a crucial metric for watching where core inflation could be heading.

If that’s the case, then there’s trouble ahead. Supercore posted its largest gain in six months. The annual change sits at 3.2% and has accelerated for four months in a row.

So inflation could become an even bigger problem in the months ahead. And one corner of the market is delivering a similar warning…

Bonds Are Struggling for Traction

Inflation-sensitive areas of the capital markets should rally on falling inflation. Longer-term Treasury bond yields are extremely sensitive to inflation. That’s why you should follow their reaction this week.

A few key things… Bonds pay a fixed coupon payment. An increase in inflation reduces the purchasing power of those payments. So when it looks like inflation is going to be a problem, bond yields tend to rise to compensate for the loss in purchasing power.

And remember that bond prices move opposite to yields, with prices falling when yields are rising.

So the action in the iShares 20+ Year Treasury Bond ETF (TLT) following the CPI report was notable.

As the name suggests, TLT tracks long-term bond prices. And TLT fell on the day that the CPI came out, even though the S&P 500 was jumping to new highs.

When you have a key piece of macro data like inflation reports, you generally want to see the same confirming signal from different markets. When you don’t, it undermines what the data is telling you.

Of course, TLT is recovering from the single-day decline. But it’s still trading near the lows from over the past two years.

And that’s giving us some price action to watch. Here’s the chart:

TLT has tested the $85 area as a key support level several times since late 2023. But the rallies off that level have been getting smaller.

That makes it a key chart level to monitor ahead. If it keeps falling, it will be one more red flag on the inflation outlook.

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict