JPMorgan's Kelly Says Fed Should Hold as Inflation Cools to 3.4%

The Federal Reserve should hold its benchmark rate unchanged after July data showed underlying US inflation cooling to 3.4 percent, with no evidence of a wage-price spiral forming, JPMorgan Asset Management's chief global strategist said.

"They absolutely should stay put, and I actually think they will do so," David Kelly, chief global strategist at JPMorgan Asset Management, said Wednesday after the Labor Department released its July consumer price index. "The US is basically 'Teflon-like inflation' now, it doesn't stick."

The report showed headline CPI rising 0.1 percent month over month, reversing June's 0.4 percent decline, while the annual rate eased to 3.4 percent from 3.5 percent. Core CPI, which strips out food and energy, rose 0.2 percent on the month and slowed to 2.5 percent year over year from 2.6 percent. US Treasuries held gains after the release, with the 10-year yield steady as investors weighed the softer print against a Fed that dropped forward guidance after its June meeting.

Kelly's call runs counter to a bond market that has pushed real yields higher since the Fed abandoned forward guidance, with the 10-year real yield now exceeding the breakeven inflation rate for the first time since 2008. If inflation keeps cooling while the Fed holds, the case for a cut strengthens into the September meeting, though officials have given no signal on timing.

The Fed has held its benchmark rate since its June meeting, and Kelly argued the disinflation trend gives officials room to stay patient. The energy index, which fell 5.7 percent in June and helped push headline CPI into negative territory, is expected to exert less downward pressure in July, yet Kelly said the broader price picture remains benign. Weak nonfarm payrolls released last week have raised expectations that the Fed will hold and eventually consider cuts, according to HSBC, which expects another soft inflation reading. The muted reaction to that payrolls report, which failed to trigger a meaningful decline in 10-year and 30-year yields, shows how term premium, not inflation, is now the dominant force in the Treasury market.

Real Yields Outpace Inflation Expectations

The bond market's reaction matters more than the headline number. Since the Fed removed forward guidance after the June FOMC meeting, following Kevin Warsh's first press conference, the 10-year real yield has climbed above the breakeven inflation rate, a divergence not seen since 2007. That gap crossed on June 22, suggesting term premium, the extra compensation investors demand for holding long-dated Treasuries, is now driving yields rather than inflation expectations, which have declined since mid-May.

The last time real yields exceeded breakeven inflation was in 2007, preceding the housing bubble's collapse. Kelly's view implies the current move is a repricing of policy uncertainty rather than a signal that inflation is re-accelerating, and that the Fed's patience will eventually be rewarded as price pressures fade.

The divergence carries implications for equities. The spread between the S&P 500's forward earnings yield and the 10-year TIPS rate stands at 2.6 percent, a cushion that has narrowed as real yields climb. Before the dot-com bubble burst in 2000, that spread had turned negative, showing how rising real yields can eventually pressure valuations even when inflation is benign.

Prediction markets such as Kalshi see headline CPI at 3.3 percent year over year, below the 3.4 percent consensus, while CPI swap contracts price 3.4 percent. If the data undershoots and bond yields still refuse to fall, that would signal the market is demanding a higher term premium regardless of inflation — a dynamic that could keep pressure on risk assets even as the Fed holds. Kelly's view, by contrast, is that the Fed's restraint will prove sufficient as "Teflon-like" inflation fails to stick.

This article is for informational purposes only and does not constitute investment advice.