In a significant development, global markets are experiencing a broad-based rally following a surprising shift in expectations for U.S. Federal Reserve interest rate policy.
The catalyst for the move was the latest U.S. inflation data, which came in lower than anticipated.
On the evening of July 14th, European stock markets, U.S. index futures, and the FTSE China A50 futures index all surged sharply higher.
Prices for gold and silver jumped by 2%.
Meanwhile, the U.S. dollar index and the VIX volatility index, often called the "fear gauge," plummeted.
The positive news stemmed from the U.S. Consumer Price Index data for June, which finally showed a decline.
The U.S. Bureau of Labor Statistics reported that the CPI fell 0.4% in June compared to May, marking the first monthly drop in six years, largely dragged down by the biggest drop in gasoline prices since 2022. The index increased 3.5% year-over-year.
Economists surveyed by Dow Jones had expected a 0.2% monthly decline and a 3.8% annual increase. The May CPI had risen 4.2% year-over-year. The June monthly drop in overall inflation was the largest since April 2020.
The core inflation rate, which excludes food and energy, was flat month-over-month and increased 2.6% year-over-year. Market expectations were for a 0.2% monthly rise and a 2.9% annual increase, matching May's annual gain of 2.9%.
This report indicates that as the worst of the energy price shock from the Iran conflict begins to fade, falling oil prices in June provided some relief for consumers. Federal Reserve officials are likely to welcome this data, especially with their policy meeting scheduled for the end of this month. However, renewed hostilities between the U.S. and Iran pushing oil prices higher again could prolong the conflict's inflationary impact.
Following the data release, U.S. stock index futures rose and Treasury yields fell as investors scaled back bets on a Fed rate hike in July. In prepared testimony for a House Financial Services Committee hearing, Fed Chair Kevin Warsh stated that the Fed has "zero tolerance" for persistently high inflation.
Specifically, falling prices for goods like apparel and used cars helped contain the core inflation measure. Motor vehicle insurance costs also saw a significant decline.
Gasoline prices fell nearly 10%, while rising prices for beef, eggs, and dairy products pushed grocery costs higher for a third consecutive month.
At the same time, hotel accommodation prices recorded their largest drop in over a year after four straight months of increases. Some economists had previously thought that demand from spectators for the FIFA World Cup matches spread across 11 U.S. host cities could drive up lodging costs. Restaurant prices saw only a modest increase.
Prices for computer software and accessories surged 2.3% month-over-month and 17.4% year-over-year, setting a record for the largest annual increase.
Minutes from the Federal Open Market Committee's June 16-17 meeting, released last week, showed policymakers' growing concerns about inflation, including a scenario where it could remain elevated due to a combination of strong demand from AI, the Middle East conflict, and former President Trump's tariff policies.
The yield on the two-year U.S. Treasury note, which is sensitive to the near-term outlook for Fed policy, fell as much as 14 basis points to 4.14%, on track for its biggest daily drop since February. The interest rate swaps market now prices in roughly a 20% chance of a Fed rate hike later this month, down from over 40% previously.
Dan Carter, Senior Portfolio Manager at Fort Washington Investment Advisors, commented: "This is a comprehensively lower-than-expected report. The possibility of a rate hike in the near term is essentially off the table. The market had been worried about an overheated inflation number, so this data should be good for bonds and help re-steepen the yield curve. Our base case has been that the Fed will remain on hold, and this data further supports that view."
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