CPI lowered the risk of a rate hike in July, but expectations have not disappeared.

Original title: CPI lowers the risk of a rate hike in July, but expectations have not disappeared

Original author: Huo Huo

Original source:

Reposted from: Mars Finance

TL;DR

· US June CPI came in below expectations, and traders lowered their bets on a July rate hike.

· Falling energy prices were the main driver, while slower growth in housing costs increased the data’s credibility.

· Related assets: US Treasuries, the US Dollar Index, growth stocks, BTC, ETH, and crude oil.

After the US June CPI was released, the rates market quickly cut back on expectations for a July rate hike. US Treasuries rebounded, US stocks rose, and crypto assets also got a brief respite.

Data released by the US Bureau of Labor Statistics on July 14 showed that June CPI, seasonally adjusted, fell 0.4% month-on-month; year-on-year, it dropped from 4.2% in May to 3.5%. Core CPI, excluding food and energy, was flat month-on-month, and year-on-year it eased from 2.9% to 2.6%. For traders, this set of data directly raised the bar for the Federal Reserve to continue hiking in July.

On the same day, Federal Reserve Chair Kevin Warsh emphasized in testimony to Congress that the FOMC has “zero tolerance” for persistent high inflation. He did not provide any signal on the next policy move, nor did he suggest that one month of lower inflation is enough to confirm a policy shift.

The split in what the market is pricing is clear. Is June CPI a turning point for policy, or just a temporary cool-down driven by gasoline prices?

Lower CPI gives the market a window for no hike

Individual investors first need to distinguish between two versions of CPI. Headline CPI includes volatile items such as gasoline and food, directly affecting how the market views the inflation number. Core CPI excludes food and energy and is closer to the measure the Federal Reserve uses to judge underlying inflation pressure.

The market moved first on the June figures because both readings looked good. Headline CPI turned negative month-on-month, indicating a clear decline in price pressure that month. Core CPI was zero month-on-month, easing concerns that “energy fell but service prices were still sticky.”

This data disrupted the earlier rate-hike narrative from the past few weeks. AP reported that after the CPI release, traders expected the probability of a July rate hike to fall to below 17%, from around 42% the previous day. The yield on 10-year US Treasuries also fell from 4.62% on Monday to 4.58%.

This round of price action is not a repricing driven by improving corporate earnings. It is a change in expectations for the rate path. US Treasuries benefit most directly because lower perceived rate-hike risk pulls yields down. Growth stocks and crypto assets are more sensitive to the discount rate and are more likely to rebound when rate pressure eases.

So the market reaction is reasonable. At least based on one month of data, the Federal Reserve does not need to slam the brakes again in July.

Warsh did not give the market a signal of a turn

Warsh’s testimony matters not only because his wording is more hawkish, but also because this is a key moment for the newly appointed chair to build policy credibility before Congress.

His core stance is straightforward. The Federal Reserve will not tolerate persistent high inflation, and it will not abandon its anti-inflation posture just because CPI looks good. A more accurate understanding is that the June data reduced near-term pressure for further hikes, but it cannot automatically be translated into a dovish signal.

This is not inconsistent with how the futures market reacted. Traders are pricing the probability of the next meeting, while Warsh is preserving policy choice over the coming months. The former can adjust quickly based on one piece of data, but the latter cannot allow the public to believe the Federal Reserve has already relaxed its vigilance.

The June FOMC just held the federal funds target range at 3.50%-3.75%. The June economic projections showed the median federal funds rate at 3.8% by the end of 2026, slightly above the midpoint of the current range. If Warsh turned dovish after one month of CPI, it would actually weaken the credibility of “prioritizing price stability.”

The more appropriate way to describe it now is not that the Fed is turning to easier policy, but that the threshold for a July rate hike has been raised. That distinction will determine how far the rebound in risk assets can go.

Gasoline and rent decide the data’s significance

The biggest highlight of the June CPI is energy, and the biggest uncertainty is also energy.

The data show that the energy index fell 5.7% month-on-month, while gasoline prices fell 9.7% month-on-month. Using the BLS methodology, falling energy prices were the largest contributing factor to the headline CPI decline in that month, offsetting increases in housing and food prices.

The issue is that gasoline prices are very volatile. They can bring short-term “inflation surprises” to the upside or rebound quickly under geopolitical risks or supply disruptions. If oil prices rise again, the market’s optimism about the June data will be quickly undermined.

Housing costs are another key detail. Housing costs rose 0.1% month-on-month in June, the smallest monthly increase since January 2021. Rents and owners’ equivalent rent have high weights in the CPI. If this component keeps slowing, the decline in core inflation will have more persistence.

But a one-month rent reading is not enough to prove that the trend is complete. Service inflation tends to be slower and “stickier” than gasoline-driven moves. If wage growth does not cool down in tandem, companies may still pass costs on to consumers. What the market is buying now is the possibility that a slow-moving factor is starting to loosen—not an outcome that has already been realized.

The rebound needs more data to carry it forward

For traders, the short-term takeaway is clearest. The risk of a July rate hike has dropped noticeably, giving risk assets a reasonable window to rebound. But this window is not unlimited; it needs subsequent data to keep proving the case.

If oil prices rise again due to geopolitical risks, the optimism generated by the June headline CPI could be quickly diluted. Energy prices may not directly change core CPI, but they can affect inflation expectations and may reawaken the Fed’s concern about “second-round” inflation.

If the next core services, wages, and rents do not continue to cool, Warsh’s caution could regain the upper hand. Then the market may find that the June CPI only pushed the July rate-hike risk further out, rather than fully erasing the tightening risk for the rest of the year.

To keep repricing bonds and risk assets toward easier conditions, inflation pressure needs to be shown over several consecutive months to fall from the energy side to the services side. Until then, this rebound looks more like a trade where rate-hike risk declines, rather than a confirmation of a new easing cycle.