US Inflation: CPI down 0.4% in June, Fed expected to pause rate hikes
The US CPI fell 0.4% in June, far more than expected, crushing expectations of a Fed rate hike in late July. Core CPI remained stable, while Governor Chris Waller had conditioned his support for a hike on a decline in underlying inflation.
US inflation slowed sharply in June, crushing speculation of an imminent monetary tightening by the Federal Reserve. The Consumer Price Index (CPI) fell 0.4% month-over-month, versus a consensus of -0.1% and after a 0.5% rise in May. Year-over-year, CPI stands at 3.5%, far from the expected 3.8% and the previous month's 4.2%.
The monthly decline of 0.4% is the largest in several years and is mainly due to the drop in energy and durable goods prices. Economists point out that this rapid disinflation could prompt the Fed to adopt a more accommodative stance. Indeed, the May CPI had risen 0.5%, sparking fears of an inflationary resurgence. The June figure completely reverses this trend.
The core CPI index, which excludes food and energy, came in flat in June, versus an expected rise of 0.2% and a 0.2% increase in May. On an annual basis, core CPI reached 2.6%, below forecasts of 2.8% and May's 2.9%. This monthly stability is particularly significant as it shows that underlying inflation, often considered more persistent, is also easing.
This release comes after Fed Governor Chris Waller indicated yesterday that he would favor an immediate rate hike if core CPI did not decline in this report. Waller's comments, considered hawkish, had raised expectations of a rate hike. The flat core CPI figure crushes this prospect and weakens the position of those advocating for monetary tightening.
Core CPI is a key indicator for the Fed as it reflects sustainable inflation trends, excluding volatile food and energy prices. Its stagnation in June suggests that underlying price pressures are fading, which could allow the Fed to keep rates unchanged at the late July meeting.
Rate hike probabilities collapse
Markets had priced in a 42% probability of a rate hike in July yesterday, versus only 8% a month earlier, according to the CME FedWatch tool. This rapid rise in expectations was fueled by hawkish comments from several Fed officials, including Chris Waller, and by the high May inflation figures. However, the June CPI report has completely reversed the trend.
Probabilities of a rate hike in July should fall to near zero after this release. Moreover, markets are beginning to anticipate a possible rate cut by the end of the year. Fed Chairman Kevin Warsh is set to testify before Congress in about 90 minutes on the state of the economy. His statements will be scrutinized to confirm the central bank's change in direction.
The CME FedWatch is a tool based on fed funds futures prices, which estimates the probabilities of rate changes. The sharp shift in probabilities shows how sensitive markets are to inflation data. The Fed's July 28-29 meeting will now be highly anticipated to see if the committee maintains its status quo or considers easing.
Market reaction: Bitcoin and US stocks rise
Bitcoin extended its gains after the release, reaching $63,400, up about 2% over 24 hours. The cryptocurrency often benefits from a low or stable rate environment, as it is perceived as a risky and alternative asset. US stock index futures also rose, with the Nasdaq 100 gaining 1.25%. Technology stocks, sensitive to interest rates, are particularly supported by the prospect of a less aggressive Fed.
Bond yields fell: the 2-year US yield lost 7 basis points to 4.19%, and the 10-year 5 basis points to 4.56%. The decline in yields reflects expectations of a shorter tightening cycle. The spread between the 2-year and 10-year, a recession indicator, widened slightly, a sign that investors see lower long-term rates.
Equity and bond markets are reacting consistently: lower inflation reduces the need for high rates, which is positive for stocks (lower cost of capital) and for bonds (rising prices). Bitcoin, though volatile, follows this trend as a risky asset.
