The June Inflation Beat Is a Mirage — Leading Indicators Tell a Different Story

The June CPI came in at 3.5% year-over-year, down from 4.2% in May. Core inflation ticked to 2.6%, the lowest reading in months. The market exhaled. Some Fed officials got a bit more comfortable. Investors who'd been waiting for a green light on rates got at least a flicker of one.

But here's what the market is getting wrong. The June inflation report was a one-off event disguised as a trend. It was driven by energy prices collapsing 5.7% in a single month following a Middle East ceasefire. That's a temporary tailwind, not structural disinflation.

The data you should actually be watching — the input prices that manufacturers and service providers are paying today — are telling a completely different story. And those leading indicators have been flashing a warning for months.

The ISM prices subindex doesn't lie

The Institute for Supply Management releases monthly surveys of purchasing managers across manufacturing and services. Their prices subindex measures whether businesses are paying more for raw materials, labor, freight, and financing. A reading above 50 means input costs are rising. Readings above 70 mean they're rising fast.

In July, the ISM manufacturing prices index came in at 71.1. That's 21 points above the 50 threshold separating rising from falling costs. The ISM services prices index registered 70.3, marking the fourth time in five months it has exceeded that 70% level.

To put that in context: 71 means that 71% of surveyed purchasing managers are reporting higher input costs, while only 29% report lower. That is not the footprint of an economy where inflation is going away. That is an economy where businesses are still absorbing steep cost increases.

The manufacturing prices index has been above 70 for months, even as it edged down from 73.0 in June to 71.1 in July. It's decelerating from a very high level — not returning to anything resembling normal. Input costs remain elevated due to tariffs, metals prices, transportation constraints, and geopolitical uncertainty, according to the ISM report itself.

The real economy is accelerating — and that matters for prices

Here's the setup that the headline CPI obscures. The ISM manufacturing PMI jumped to 55.6 in July, up from 53.3 in June and the strongest reading since May 2022. Production surged to 58.5 — the highest since November 2021. New orders expanded at 56.7 for the seventh consecutive month.

What's even more telling: customer inventories fell to 40.7, meaning buyers' stockpiles are too low. The backlog of orders jumped to 55.0. Manufacturing employment finally returned to expansion at 52.8, the first time in 33 months.

When demand is accelerating, inventories are thin, backlogs are growing, and input costs are surging — that is the exact combination that feeds consumer inflation with a lag. Manufacturers facing rising costs and strong demand don't absorb those costs. They pass them through.

The June CPI headline drop came precisely because energy prices fell sharply, not because the underlying cost structure of the economy reset.

Consumer inflation expectations haven't come down

If you want to know whether the inflation mindset is shifting, look at what consumers expect, not what they feel today. The University of Michigan's July survey showed year-ahead inflation expectations at 4.2%, down from 4.6% in June — a modest improvement, but still more than double the Fed's 2% target.

More important: long-run inflation expectations sat at 3.3%. That number has been stuck well above 2% for over a year. It tells you that consumers don't believe the inflation problem is solved. They expect it to persist. When workers build 3.3% inflation into their wage demands and businesses build it into their pricing, that self-reinforcing loop is very hard to break.

Consumer sentiment itself rebounded sharply in July, with the Michigan index jumping from 49.5 to 55.2, but that's precisely because energy prices fell and gave households temporary breathing room. The underlying inflation outlook hasn't materially changed.

The Fed is divided — and that's a signal, not noise

At the July 29 FOMC meeting, the Federal Reserve held rates at 3.50%-3.75% by a vote of 9-3. Three regional presidents — Beth Hammack of Cleveland, Neel Kashkari of Minneapolis, and Lorie Logan of Dallas — dissented, favoring a quarter-point hike.

Three dissenting votes is not a trivial split. It signals that experienced Fed officials see inflation risks that the majority isn't ready to act on yet. Governor Christopher Waller, who voted to hold, still said it would take "several months of positive readings" to convince him inflation is returning to the 2% target.

Chairman Kevin Warsh came out and said the 2% target is absolute: "There is no soft implicit target. Not on this committee's watch." He cited tighter financial conditions — with the 10-year Treasury yield hovering near 4.6% — as a reason the economy is already feeling monetary restraint.

But Warsh's own rhetoric has been that controlling inflation is the centerpiece of his tenure. If July's CPI comes in hot, the pressure on him to act will be enormous. And the market, which had priced in a September hike before pulling back to roughly a 42% probability following a weak July jobs report, will swing again.

What the weak jobs report actually means

July's nonfarm payrolls declined by 23,000 — an unexpected drop — and May and June were revised down by a combined 103,000. The unemployment rate fell to 4.1%, though the labor force itself is contracting.

The market interpreted this as inflation-killing weakness. I don't think that's the right frame. A contracting labor force with stable unemployment doesn't mean the economy is cooling into a soft landing. It means fewer people are available to supply goods and services. Labor force constraints are inflationary, not disinflationary — because they limit the economy's ability to produce without pushing up wages.

Plus, the jobs data came in a single month. One weak print against the backdrop of ISM employment returning to expansion in manufacturing is too thin a reed to build a recession thesis on.

The August 12 test

The July CPI report drops on Wednesday, August 12th. That's the real moment of truth. The June CPI benefit from falling energy prices will fade as that one-time decline drops out of the year-over-year comparison. If core services inflation hasn't meaningfully decelerated, July's headline number could reaccelerate.

The ISM prices data suggests it should. Manufacturers are still paying elevated input costs. Service providers are still raising prices. Demand is accelerating, not slowing. Consumer inflation expectations are anchored well above the Fed's target.

What this means for your portfolio

I believe inflation is likely to remain more persistent than the market wants to admit, but that does not mean every high-yield stock is attractive. The winners still need pricing power, balance-sheet strength, and a payout profile that can survive a full cycle.

When you see input costs surging across manufacturing and services, the companies that benefit most are the ones that can pass those costs through to customers without losing demand. That's the pricing power filter, and it eliminates most candidates.

Energy, industrials, and logistics companies that provide products the economy cannot function without — what I call TOLL stocks, not FANG — are positioned to raise prices when costs rise and to grow dividends through whatever inflation regime emerges. Companies without that pricing ability will see margins compressed and dividends at risk.

From an income and risk/reward point of view, I don't need the Fed to hike aggressively in September for this setup to make sense. The structural drivers — tariffs, deglobalization, supply constraints, energy transition, and a labor force that's shrinking — are pricing pressures that exist regardless of what the Fed does at any one meeting. They're the reason I focus on dividend growth companies in the real economy that can compound income through multiple inflation cycles.

The June CPI was a gift from falling oil prices, not a victory for monetary policy. The leading indicators say the real test hasn't happened yet. August 12th is when we'll start to find out whether disinflation is genuine — or just borrowed from a temporary energy tailwind.

I expect the latter. And that's exactly the regime where owning the right kind of pricing power matters most.