CPI and PPI both softened. Why are markets still hesitant?

This week brought a key test for U.S. inflation data and interest-rate markets. On Wednesday, July CPI was 3.4% year over year, below June's 3.5%; core CPI excluding food and energy was 2.5%, also below June's 2.6%. On Thursday, July PPI was flat from the previous month, below the market's expectation of a 0.2% rebound. During the same period, markets continued to digest the unusual 9–3 vote at last month's Federal Reserve policy meeting to leave rates unchanged.

Despite this seemingly favorable set of mild inflation readings, the week's market reaction was strikingly restrained. Treasury yields and the dollar index stayed within narrow ranges after both reports. Expectations that the Fed would hold rates steady in September firmed, but major asset classes did not develop a one-way trend simply because inflation was mild.

Many investors were puzzled. Markets have focused intensely on whether U.S. inflation would reaccelerate, and in the recent past a cool CPI reading would lower the probability of a rate increase and send assets rallying. Why, this time, did pricing for the Fed's policy path remain hesitant even though both CPI and PPI were relatively mild?

Understanding the deeper logic behind this week's market behavior requires George Stigler's theory of the cost of searching for information. Stigler, a foundational figure in information economics and the economics of regulation, received the Nobel Prize in Economic Sciences in 1982.

Stigler's central insight was that markets never operate in a vacuum of complete information. Information has a cost: searching for it, filtering it, comparing it and interpreting it all require effort. After investors receive a set of public data, a clear conclusion does not appear automatically. They must still decide how much weight those data carry in the current decision framework.

Applied to this week, the central problem for the Fed's policy path is not that markets lack CPI and PPI data. It is that they lack a sufficiently stable and explicit framework for interpreting policy.

When a core variable changes fundamentally, markets are no longer trading a simple monthly inflation report. They are forced to search again for, and reprice, the Fed's reaction function.

Through Stigler's information-economics framework, moves in Treasuries, the dollar and related assets this week form a clear chain of logic.

First, mild CPI and PPI readings reduced only the pressure for a near-term rate increase

Both headline and core CPI slowed year over year in July, while PPI was flat from the previous month. For short-term rates, such data directly affect the probability of action at the next meeting. With neither producer nor consumer prices reaccelerating, the need for the Fed to raise rates immediately in September fell sharply. That is why markets became more inclined to bet on no change. The front end reflects near-term meeting probabilities; as long as the data do not add to inflation pressure, bets on an imminent rate increase naturally recede.

Second, mild data did not automatically reduce the cost of interpreting the longer policy path

CPI and PPI are not the only price measures the Fed watches. Policymakers now pay closer attention to the path of PCE inflation, while the rebound in international oil prices since July could still have a material effect on later inflation readings. A single CPI or PPI report therefore cannot lock in the policy path for the entire second half of the year.

In the past, investors could rely heavily on the chair's remarks, the dot plot and clear forward guidance to judge how the Fed would interpret the data. The Fed under Warsh has sharply reduced forward guidance, stressed that it will no longer signal the future path so extensively, and even treats financial-market prices themselves as a variable for the central bank to observe.

When a central bank withdraws this free policy navigation, the information cost of judging its path rises abruptly. Mild data alone can no longer remove long-term uncertainty.

Third, higher information-search costs produced divergent pricing across major assets

When markets lack a stable interpreter of policy, the same inflation data receive very different weights in different assets.

That was the clearest feature of this week's trading. Short-term rates could price a lower probability of an increase after mild CPI, while long-term rates remained under pressure from the credibility of long-run inflation control, the fiscal deficit and the term premium. The dollar did not weaken in a straight line because relative interest-rate differentials across countries still drove capital flows. Gold benefited from lower near-term rate-increase risk, but the opportunity cost of holding it could return at any time if the yield curve failed to flatten decisively.

Stigler reminds us that more information does not necessarily create more clarity. What matters is whether markets can turn information into executable decision rules at low cost. The issue this week was not that CPI and PPI were meaningless, but that the data could not answer on their own how the Warsh-led Fed would distribute decision weight among PCE, the oil-price rebound, the labor market, long-term Treasury yields and disagreements among officials.

In such an environment of high interpretation costs, the next trading decisions require a more three-dimensional framework.

1. Move from looking only at one month's CPI and PPI to examining how the data enter the Fed's reaction function. Under the new communication approach, one CPI report can no longer determine the trend by itself. PCE inflation, the scale of the rebound in commodity prices and labor costs must be considered together in a broader inflation-tracking matrix, avoiding a blind chase after a favorable single release.

1. Follow closely how the pieces of the Fed's policy framework come together. Forward guidance has diminished, but the 9–3 vote split shows that officials are engaged in an intense debate over direction. Subsequent remarks from Fed officials deserve close attention while markets wait for a central policy anchor capable of sharply lowering the information-search cost for everyone.

1. Watch for delayed transmission of policy-information costs across assets. With less forward guidance, short-term rates, long-term rates, the dollar and gold may respond differently to the same data. Volatility may come from the data themselves or from the market's process of relearning the policy rules.