US inflation cools to 3.5% in June as energy prices tumble

US consumer prices rose 3.5% in June from a year earlier, the slowest pace in three months, as a sharp drop in gasoline prices delivered the largest monthly decline in headline inflation since April 2020.

"The weaker inflation data likely keeps the Fed on hold for now and reduces any rate hike odds, but we remind investors that almost every communication from Chair Warsh has been hawkish," Skyler Weinand, chief investment officer at Regan Capital, said.

The consumer price index fell 0.4% from May, the Bureau of Labor Statistics said Tuesday, beating the 0.1% decline economists had forecast. Core CPI, which excludes food and energy, was unchanged month over month and rose 2.6% annually, down from 2.9% in May and below the 2.8% consensus estimate. Energy prices tumbled 5.7% month over month, with gasoline falling 9.7%, as a fragile ceasefire in the Persian Gulf temporarily eased supply fears.

The reprieve may prove fleeting. The truce collapsed last week after commercial tankers came under fire in the Strait of Hormuz, triggering military strikes between the United States and Iran. The national average gasoline price has already reversed course, rising to $3.86 a gallon Tuesday from $3.79 a week ago, according to AAA. With oil prices climbing to a four-week high after the US reimposed a naval blockade, the disinflationary tailwind from June's energy slide is unlikely to persist.

Sticky services keep core elevated

Core services inflation outside of housing has proven stubbornly persistent, running at an annual rate that has accelerated through the first half of the year. Labor-intensive sectors such as healthcare, auto repair and insurance continue to push prices higher as businesses pass along wage costs. The last time core services inflation ran this hot for this long was in the cycle preceding the Fed's 2022 tightening campaign, when the central bank raised rates by 75 basis points at four consecutive meetings.

Housing costs, which account for the largest share of the CPI basket, have been on a slow but steady disinflationary path and are now running at a pace last seen between 2016 and 2019. That provides some cushion, but not enough to offset the upward pressure from other services categories.

Wages and the Fed's next move

Nominal wages rose 3.5% in June, matching the headline inflation rate and breaking a streak of declining real wages, according to BLS data. For lower-income households, however, the picture remains strained. Numerator data show everyday goods prices have risen 35.7% for low-income consumers since January 2018, compared with a national average of 33.8%.

Financial markets reacted swiftly to the data. The S&P 500 and Nasdaq both rose after the release, while the Dow was pressured by a 20% slide in IBM stock. CME FedWatch showed an 83% probability of the Fed holding rates at its July 28-29 meeting, up from roughly 60% before the data. The central bank's benchmark rate currently stands at 3.50% to 3.75%, where it has been since the June meeting. Minutes from that gathering published last week showed policymakers' concerns about inflation mounted, with new projections revealing a growing sentiment around a likely rate hike in 2026.

"The increase in energy prices from February through May, and the businesses that took on those extra costs, those are still in the system," Claudia Sahm, chief economist at New Century Advisors, said. "They're showing up in other types of goods prices or services prices."

The Fed's preferred inflation gauge, the Personal Consumption Expenditures price index, has not been below 2% since early 2021. With the Iran conflict escalating and AI-driven data center buildouts pushing electricity prices up nearly 6% over the past year, the path back to the central bank's target remains uncertain.

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