Expected Lower US CPI...Will Tightening End After July Rate Hike? (Summary)

Ahead of the U.S. Federal Reserve's (Fed) benchmark interest rate decision, the Consumer Price Index (CPI) inflation rate fell to its lowest level in over two years. The inflation rate, which had surged to the 9% range last year, dropped to 3%. Market expectations are growing that the Fed's tightening could end after this month's baby step (a 0.25 percentage point rate hike).

[Image source=Reuters Yonhap News]

U.S. CPI Rises 3%, Below Expectations... Core CPI Also in the 4% Range

According to the U.S. Department of Labor on the 12th (local time), the June CPI rose 3.0% year-over-year. This was below Wall Street's forecast of 3.1%, marking the lowest level since March 2021. The CPI inflation rate falling below 4% is the first time since April 2021. The June CPI also recorded a 0.2% increase month-over-month, below Wall Street's expectation of 0.3%. The core CPI, which excludes volatile energy and food prices, rose 4.8% year-over-year, showing the slowest pace since October 2021. Month-over-month, it increased by only 0.2%. All these figures were below market expectations (5.0%, 0.3%).

U.S. President Joe Biden welcomed the report in a statement, saying, "Good jobs and low costs, this is exactly what Bidenomics is about," and added, "Today's report provides new and encouraging evidence that inflation is falling while our economy remains strong." He emphasized that "annual inflation has declined over the past 12 months to 3%" and pledged to continue fighting to reduce costs, including slowing inflation.

By item, declines were confirmed mainly in some products and services such as airfare and used cars. Airfare fell 8.1% in one month. Used cars and trucks dropped 0.5%. Housing costs, including rent, also showed signs of gradual slowdown. Housing costs rose 0.4% month-over-month and 7.8% year-over-year. Although still high, the increase was smaller than the previous month. Notably, the month-over-month increase was the lowest since March.

The CPI inflation rate easing to its lowest level in over two years is seen as a signal that the Fed's tightening, which has lasted more than a year, is having an effect. In particular, Wall Street places significance on the core CPI, which had consistently remained above 5% and fueled concerns about prolonged tightening, finally dropping to the 4% range. The New York Times (NYT) reported, "The slowdown in core CPI, closely watched by the Fed, is noteworthy," calling it "good news for consumers and the Fed."

Market expectations for a soft landing have also increased. George Mateyo, Chief Investment Officer at Key Private Bank, said, "We have finally confirmed that inflation is cooling. The Fed will take this report as evidence that its tightening policy is having the desired effect," adding, "Inflation has eased, but growth has not yet stopped." Bethany Stevenson, an economics and public policy professor at the University of Michigan, also appeared on CNBC's Squawk Box, saying, "We are seeing a slowdown without a labor market collapse. Inflation is also slowing," describing this as "the picture of a soft landing."

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"Too Early to Declare Victory" Rate Hike Likely in July

However, since the core inflation closely monitored by the Fed remains near 5% and there is still a long way to go to the 2% price stability target, a rate hike is still likely at this month's FOMC meeting. Mateyo welcomed the June CPI report as "significant progress" but assessed, "It does not seem likely to prevent the Fed from raising rates at the end of this month." This aligns with recent remarks by most Fed officials who say it is too early to declare victory in the fight against inflation.

Lisa Sturtevant, Chief Economist at BrightMLS, pointed out, "Housing costs, which make up a large part of inflation, have not yet fallen to a meaningful level." According to the Department of Labor, housing costs, including rent, accounted for more than two-thirds of the core CPI increase in June. Housing and other service prices have long been cited by Fed Chair Jerome Powell as the main culprit of sticky inflation alongside an overheated labor market.

Accordingly, investors are focusing on the Fed's moves after the July rate decision. Jim Reid, strategist at Deutsche Bank, predicted, "The July rate hike is almost certain, but everything is possible afterward." Earlier, the Fed kept rates steady at the June FOMC while signaling through the dot plot that two rate hikes could occur this year. The remaining meetings this year are four: including this month's on the 25th-26th, September, November, and December.

Some expect the Fed's tightening pause to come sooner than anticipated. JP Morgan previously predicted that if the June CPI inflation rate hits 3%, the Fed could hold rates steady after this month's baby step (0.25 percentage point hike) through the end of the year. Julia Pollak, Chief Economist at ZipRecruiter, analyzed the CPI report, saying, "The Fed is more likely to pause rate hikes after the last increase in July and gradually lower rates through 2024."

Market consensus also favors a rate hike in July followed by a pause in September. According to the Chicago Mercantile Exchange (CME) FedWatch, the federal funds (FF) futures market was pricing in about a 93% chance of a baby step in July as of the morning. The probability of a pause in September rose to the 80% range, up from the 70% range the previous day. The chance of an additional baby step in September was only in the 12% range. The Wall Street Journal (WSJ) reported, "The rate futures market is betting that the July hike could be the last."

Following the CPI release, the New York stock market is rallying on relief. The Dow Jones Industrial Average, composed of blue-chip stocks on the New York Stock Exchange (NYSE), is trading about 0.38% higher than the previous close. The large-cap S&P 500 index and tech-heavy Nasdaq index are also recording gains of around 0.6% and 0.7%, respectively. The Volatility Index (VIX), known as Wall Street's fear gauge, fell to around 13.7, well below its long-term average of 20.

With easing concerns about tightening, Treasury yields declined. In the New York bond market, the 2-year U.S. Treasury yield, sensitive to monetary policy, fell to around 4.73%. Treasury yields and prices move inversely.

This content was produced with the assistance of AI translation services.