US inflation cools to 3.5% in June as yields drop 10bps

The June CPI report delivered the strongest disinflation signal in more than six years, cutting the odds of further Federal Reserve tightening and sending Treasury yields sharply lower.

US consumer prices fell 0.4% in June from the prior month, the largest monthly decline since April 2020, pushing the annual inflation rate to 3.5% and sending two-year Treasury yields down nearly 10 basis points. The Bureau of Labor Statistics said headline CPI rose 3.5% from a year ago, below the 3.8% consensus estimate and down from 4.2% in May.

"The Fed was losing patience with high inflation, and today's cooler-than-expected report gives them room to breathe," said Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management.

Core CPI, which excludes food and energy, was unchanged on the month and up 2.6% year-over-year — both readings missing forecasts of 0.2% and 2.8%, respectively. Energy prices fell 5.7% on the month, the largest decline since April 2020, led by a 9.7% drop in gasoline. Housing costs rose just 0.1%, the smallest monthly increase since January 2021, while food prices increased 0.2%.

The data sharply reduces the probability that the Federal Reserve will resume raising rates at its July 28-29 meeting. The CME FedWatch tool showed an 85.6% chance of a hold at the current 3.50% to 3.75% target range, up from 58.3% a day earlier. Markets now price zero probability of a rate cut by year-end but have trimmed expectations for further hikes.

The disinflation was broad-based. Transportation services declined 0.3% on the month, airline fares rose just 0.2%, and the meats, poultry and fish index rose 0.4% in June, with beef and veal prices surging 11.8% from a year ago. Egg prices, which had spiked during the avian flu outbreak, fell 27.9% year-over-year as supplies normalized.

"The surprises relative to our expectations in this month's release were largely in core prices where transportation services, communication services, and lodging away from home were all well below our projections," UBS said. The bank noted these categories tend to be volatile but added that "even accounting for these categories and the issues with seasonal adjustment, this was not a strong CPI and is consistent with our view that last month was likely the peak for US inflation."

The bond market reacted swiftly. The two-year Treasury yield dropped 9.86 basis points to 4.1829%, while the 10-year yield fell 5.03 basis points to 4.5734%. Both had been trading near session highs before the 8:30 a.m. release in New York. The dollar weakened modestly, and Bitcoin climbed above $63,000 as risk assets rallied on the prospect of a less aggressive Fed.

Federal Reserve Chair Kevin Warsh, testifying before Congress on the same day, reinforced the central bank's commitment to price stability. "The Fed has no tolerance for persistently high inflation," Warsh said, describing the labor market as "broadly stable." His remarks removed any immediate concern that economic weakness would force a policy shift, while the CPI data gave the Fed cover to maintain its wait-and-see stance through the summer.

Jeffrey Roach, chief economist at LPL Financial, cautioned that risks remain. "After today's benign core inflation release, it appears less likely that the FOMC will raise rates over the next few meetings," Roach said. "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 last time headline CPI posted a monthly decline of this magnitude was in April 2020, when the pandemic shutdowns collapsed demand. That comparison underscores both the unusual nature of the current energy-driven disinflation and the lingering risk that a renewed escalation in the Middle East could reverse the trend. The US and Iran recently announced a memorandum of understanding, and oil prices have fallen sharply, but the underlying core inflation rate at 2.6% remains above the Fed's 2% target.

For investors, the report offers the clearest evidence yet in 2026 that disinflation is regaining traction after the Iran war-driven spike pushed inflation to a three-year high of 4.2% in May. The question now is whether the trend can sustain without a broader economic slowdown — and whether the Fed will need to eventually cut rates if it does.

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