Inflation is clearly moderating and will likely continue to do so if consumer spending remains erratic and gasoline prices stay soft.

The Federal Reserve's favorite inflation indicator, the core Personal Consumption Expenditure (PCE) index, has climbed only 1.9% in the past 12 months and is now running at its lowest rate in over three years. The core PCE rose 0.1% in June, which was the lowest monthly inflation since last November.

Under Ben Bernanke, the Fed unofficially targets inflation within a range of 1% to 2%. So as the core PCE falls, it sets up the Fed for an interest rate cut sometime this fall.

There's also been a dramatic decline in long-term bond yields to 4.8% for the 10-year Treasury bond, which was over 5.2% not too long ago. This was obviously caused by a flight to quality during the sell-off in late July. Short-term yields, however, have also declined and are now well below the Federal Funds rate.

The Fed doesn't like to fight market rates and the fact that core inflation continues to moderate is very bullish. The real reason why the Fed may want to cut rates is to shore up consumer spending and help the battered housing market, which could cause economic growth to struggle.