Geopolitical Stalemate, Cooling Inflation Keep Fed on Hold
The Middle East conflict has entered a prolonged stalemate, with both sides hardening their positions. Iran continues to insist on retaining a role in managing shipping traffic in the Strait of Hormuz, while President Trump asserts that the United States has 'total control' over the waterway.
Despite this geopolitical risk premium remaining elevated, particularly for energy markets, recent action from both sides suggests significant warfare fatigue. Energy prices will remain volatile, but oil prices returning to March/April levels seem unlikely, which could help inflation.
The US labour market and inflation continue to cool. July's US inflation and employment data point to a further moderation in aggregate activity. Headline CPI inflation slowed to 3.4% year over year, while core inflation declined to 2.5%, its lowest level since 2021. At the same time, non-farm payrolls unexpectedly contracted by 23,000.
The combination of softer inflation and weaker hiring gives the Federal Reserve greater flexibility to remain patient. Policymakers will still feel some residual pressure to hike as inflation has been above target for several years now, but the direction of travel suggests such pressures are easing.