US Inflation Cools Further in June, Bolstering Case for Fed Rate Cut

Key Insights from the June CPI Report

The latest US Consumer Price Index (CPI) report for June, released on Thursday, provided further evidence of cooling inflation, strengthening the case for the Federal Reserve to begin cutting interest rates in the near future.

Here are the key points:

1. Core CPI, which excludes volatile food and energy prices, rose just 0.1% month-over-month, falling short of economists' expectations.

2. Headline CPI dropped 0.1% from May, driven by lower energy costs.

3. On an annual basis, core CPI increased 3.3%, the smallest gain since April 2021.

4. Shelter costs registered their smallest rise since 2001, contributing significantly to the overall slowdown.

5. Financial markets reacted positively, with Treasury yields falling and expectations of a September rate cut increasing.

Broad-Based Disinflation Across Sectors

The June report revealed a broad-based cooling of inflationary pressures across various sectors of the economy. Notable areas of disinflation included: - Housing: Rental costs and owners' equivalent rent both showed significant deceleration. - Transportation: Airfares and used vehicle prices declined month-over-month. - Goods: Core goods prices fell for the fourth consecutive month, providing relief to consumers. However, some areas continued to see price increases, such as car insurance costs.

Market Reactions and Fed Policy Implications

The subdued inflation reading has heightened expectations that the Federal Reserve may start cutting interest rates as soon as September. Interest-rate futures markets have almost fully priced in a September rate cut, with at least two reductions anticipated by the end of the year. Treasury yields responded by dropping sharply, with two-year yields falling about 13 basis points to 4.49% while the 10-year yield dropping 10 basis points to 4.19%. Stock futures initially rose but later gave up much of their gains, while the dollar experienced its most significant drop against the yen in over two months.

Implications for Federal Reserve Policy

The June CPI report is likely to boost the Federal Reserve's confidence in the ongoing disinflation process. While the central bank's next meeting in July may be too soon for a rate cut, the September meeting is now viewed as a strong possibility for the first reduction in the federal funds rate. Fed Chair Jerome Powell, in recent testimony to lawmakers, emphasized that policy decisions would be guided by incoming data. This latest report, combined with signs of a cooling labor market, provides support for a shift towards easier monetary policy.

Economic Indicators and Future Outlook

The broader economic context also supports the case for a rate cut. Separate data released on Thursday showed that recurring applications for jobless benefits remained near their highest level since late 2021, although first-time filings fell by 17,000, the largest drop in a year. This mixed labor market data, combined with the cooling inflation, suggests that the economy is slowing, which could prompt the Fed to ease monetary policy.

The sustained decline in goods prices and the long-awaited slowdown in shelter costs are expected to continue exerting downward pressure on inflation. However, we should be cautious against extrapolating June's sharp deceleration in housing costs, as it may partly reflect payback from an unusual spike in May.

Conclusion: A "Very Good" Inflation Report

Fed Chair Powell had previously described May's inflation report as "very good." The June data appears to have exceeded even those expectations, potentially accelerating the timeline for monetary policy easing. As the Fed approaches its July 30-31 meeting, it will have additional data points to consider, including the Personal Consumption Expenditures (PCE) price index – the Fed's preferred inflation gauge. While a July rate cut remains unlikely, the probability of a September reduction has increased significantly. The Fed's confidence in the sustainability of the disinflation trend is growing, setting the stage for a potential pivot in monetary policy before year-end.

Disclaimer: The views and opinions expressed herein are the author's individual opinions and views and do not reflect Vanguard Investments views. These views are expressed to share insights and opinions and DO NOT constitute any financial advice. Please consult your financial advisors for any investment advice.