US inflation cools to 3.5% in June, easing pressure on Fed

The biggest monthly drop in consumer prices in more than six years has all but erased the case for a July rate hike.

US consumer prices fell 0.4% in June from May, the steepest monthly decline since April 2020, pushing the annual inflation rate to 3.5% — well below the 3.8% economists had forecast. Core CPI, which strips out food and energy, was flat on the month — the first non-positive reading since the pandemic — bringing the 12-month rate to 2.6% from 2.9% in May.

"After today's benign core inflation release, it appears less likely that the FOMC will raise rates over the next few meetings," said Jeffrey Roach, chief economist at LPL Financial. "However, we may still be at an inflection point, given the risk that the energy shock could spill over into other categories of consumer prices."

The energy index slumped 5.7% as gasoline and fuel oil prices each fell more than 9%. Shelter costs, the stickiest component of core inflation, rose just 0.1%, while transportation services declined 0.3%. Food prices edged up 0.2%, new vehicles were flat, and used cars and trucks fell 0.2%. Apparel prices dropped 0.6%.

The pullback in headline inflation was driven almost entirely by energy, where a fragile US-Iran ceasefire that took hold last month sent pump prices tumbling. That truce has since collapsed after commercial tankers came under fire in the Strait of Hormuz, triggering US military strikes on Iran and a renewed naval blockade of Iranian ports. WTI crude rose about 1% to near $80 a barrel in Asian trading Wednesday, suggesting the June reprieve may prove short-lived.

"The long-awaited deflationary component of AI is starting to show up," said Jamie Cox, managing partner at Harris Financial Group. "This is the first print you will see of many that will show inflation abating." Information technology commodities prices fell 0.9% in June, while smartphone prices dropped 0.8%, according to the BLS data.

Markets price out July hike as bond yields slide

Treasuries rallied sharply after the report, with the policy-sensitive 2-year yield falling as much as 14 basis points to 4.14% — its biggest one-day decline since February. The 10-year yield dropped 4 basis points to 4.571%. The dollar index slid 0.6% to 100.7, while the S&P 500 rose 0.3% and the Nasdaq gained 0.6%.

The relief rally extended to Asia-Pacific markets Wednesday. South Korea's KOSPI surged more than 7%, triggering a Sidecar circuit breaker on KOSPI 200 index futures, as SK Hynix jumped 10% in Seoul after its US ADR soared 27% overnight. Samsung Electronics rose more than 7%. Japan's Nikkei 225 gained 1.49%, and the MSCI Asia Pacific index added 1.2%.

Forward path hinges on energy and shelter

The last time core CPI posted a flat or negative monthly reading was April 2020, during the pandemic lockdowns. That comparison underscores how unusual the June data is — and how dependent the disinflation narrative remains on energy prices that are already reversing.

Fed Governor Christopher Waller said Monday it would take "several months of positive readings" to convince him inflation is sustainably returning to the central bank's 2% target. The Fed's benchmark rate currently sits at 3.5% to 3.75%, where it has been since Chair Kevin Warsh took office in May.

"The headline number was helped by a large decrease in the price of energy during the month, and that's reversed itself this month," said Art Hogan, chief market strategist at B Riley Wealth. "Any concept of a July rate hike has been pushed down the road to later months."

Overnight index swaps now price a July rate hike at less than 20%, down from roughly 45% before the release. The next FOMC decision is July 28-29.

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