Data released on Tuesday revealed that the US Consumer Price Index (CPI) for June rose 3.5% year-on-year, coming in below the market forecast of 3.8% and showing a notable deceleration from the previous 4.2% reading. Month-on-month, it fell by 0.4%, marking the first monthly decline in six years. The core CPI, which excludes food and energy, increased 2.6% year-over-year, also underperforming the 2.8% expectation. Its monthly gain was 0%, a significant slowdown from the prior 0.2%.
This inflation report, which exceeded expectations on the downside, has tempered market expectations for Federal Reserve interest rate hikes. Traders have already scaled back their bets on a July move. The market-implied probability of a 25-basis-point rate increase at the Fed's July 28-29 meeting has now dropped to approximately 15%, down from around 35% previously. Concurrently, the odds for a September hike have also receded, currently standing near 70%, lower than the previous level exceeding 90%.
Market Impact and Analysis
Market analysis suggests that weakening inflation has reduced the urgency for the Federal Reserve to tighten monetary policy further in the near term, boosting overall market risk appetite. On Tuesday, the three major US stock indices closed higher, with semiconductor, memory, and optical communication stocks gaining across the board. US Treasury bonds also rallied. The yield on the policy-sensitive 2-year Treasury note fell as much as 14 basis points to 4.14%, its largest single-day drop since last August, before paring some losses to close down about 10 basis points.
Zach Griffiths, Head of Investment Grade Corporate and Macro Strategy at CreditSights, commented, "Tuesday's inflation data essentially rules out a July rate hike by the Fed. While inflation remains above target and the Middle East situation continues to deteriorate, this data is sufficient for the Fed to remain on hold."
Justin Wolfers, a Professor of Economics at the University of Michigan, similarly noted, "The softer inflation report released Tuesday reduces the pressure on the Fed to raise rates further. The Fed's next move is still most likely a hike, but the timing may be later and the magnitude smaller than many feared."
However, he also cautioned, "We are now into July, and international oil prices have risen again, raising questions about how long this inflation relief can last."
Shifting Market Focus
Some strategists pointed out that the cooling US June CPI has shifted market focus from the two dominant macro risks—rising oil prices and July rate hike expectations—to micro-level corporate earnings. Chris Lau, Portfolio Manager at DIY Value Investing, observed that the weak inflation data quickly impacted the market, stating, "The market increased bets on the Fed holding rates steady, albeit not by a huge margin."
He also noted a clear sector rotation in the US stock market on Tuesday, with IBM (IBM.US) issuing an earnings warning that "once again triggered a flight from software stocks." Meanwhile, investors rotated back into technology hardware names, including SK Hynix (SKHY.US), Micron Technology (MU.US), SanDisk (SNDK.US), and NVIDIA (NVDA.US). Server providers Dell Technologies (DELL.US) and Hewlett Packard Enterprise (HPE.US) "also saw a strong rebound."
Broader Market Perspective
Jurrien Timmer, Director of Global Macro at Fidelity Investments, analyzed the market fundamentals from a broader perspective. He stated, "As long as the fundamentals continue to support the current trend, a sharp short-term shakeout in capital will not end a bull market, and at present, the fundamentals still provide support."
Timmer advised investors to adopt a "barbell strategy," holding AI and growth stocks on one end while hedging with positions in stocks outside the AI space that offer stable income attributes. However, he also pointed out that the market's current implied inflation expectation is only 2.26%, "a level that seems too low to me."
Fed's Stance and Communication
It is worth noting that in written testimony submitted to the House Financial Services Committee on Tuesday, Federal Reserve Chair Walsh stated, "The Committee has no tolerance for persistently high inflation, and we are collectively firmly committed to restoring price stability." He emphasized that monetary policy is the top priority, and if the Fed gets its policy right, the inflation surge of the past five years will become history.
Regarding Tuesday's CPI data, Walsh said, "While this morning's CPI data came in better than expected, I do not endorse selectively interpreting the data. I believe there is still a great deal of work to be done." During the hearing, Walsh explicitly stated that if faced with pressure from President Trump, he would "do his job," and would act based on data even if criticized by Trump. This is Walsh's most direct comment to date on Trump's challenges to the Fed.
Nick Timiraos, often seen as a "Fed mouthpiece," wrote that Walsh reiterated the Fed's goal of controlling inflation but did not signal the direction of interest rates, avoiding extensive discussion of his own views on rates during the hearing. This aligns with his consistent stance that the Fed should not pre-announce its next moves, and he did not clearly define the criteria for judging when high inflation becomes persistent. Walsh's firm stance on curbing inflation may help anchor inflation expectations.
Chuck Carlson, CEO of Horizon Investment Services, said, "The message Walsh conveyed is, 'We can bring down inflation,' and that's exactly what his audience wanted to hear. Perhaps inflation can come down on its own without another rate hike."
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