Financial markets moved decisively on Tuesday to favor a pause by the Federal Reserve in late July after government figures showed inflation eased more than anticipated in June.
The U.S. Bureau of Labor Statistics reported that the Consumer Price Index rose 3.5% on a year-on-year basis in the 12 months through June, down from a 4.2% annual increase in May. The so-called core CPI, which strips out food and energy and is watched as an indicator of underlying price pressures, rose 2.6% year-on-year in June, after a 2.9% increase in May. On a month-to-month basis, core CPI was unchanged.
Those more benign readings helped reduce market concerns that recent spikes in oil prices - linked to renewed hostilities around the Strait of Hormuz - would feed into persistent inflationary momentum that must be countered by immediate Fed action. Oil had cooled through June during talks between the United States and Iran, but prices have since climbed sharply following a resumption of hostilities near the strategic waterway. Before the onset of the war in late February, about 20% of the world's crude oil supply was transported through that channel.
Traders pared back the probability of a quarter-percentage-point rate increase at the Federal Open Market Committee meeting scheduled for July 28-29. Based on Fed funds futures prices traded at the CME Group, the chance of a 25 basis point hike at that meeting fell to roughly 10% from about 35% before the release of the CPI figures. Expectations for the Fed's September 15-16 meeting also retreated; market-implied odds of a rate rise at that gathering dropped to about 60%, down from more than 90% prior to the June CPI report.
Comments from Federal Reserve officials continued to factor into market assessments. Fed Governor Christopher Waller said the central bank may need to raise rates in the "near term" if underlying inflation, measured by the core CPI, remained elevated. He added that he would want to see several months of cooler inflation readings before feeling comfortable about foregoing further hikes entirely. Waller's views, while his own, have at times signaled shifts in broader Fed thinking.
Separately, Fed Chairman Kevin Warsh was set to begin two days of testimony in Congress later that morning. According to his prepared remarks for a hearing before the U.S. House of Representatives Financial Services Committee, he planned to tell lawmakers that the central bank has "no tolerance" for persistently elevated inflation.
Economists and market strategists offered differing perspectives on the outlook. Analysts at Capital Economics wrote that they still view a future rate increase as likely, saying it is a matter of "when, rather than if" the Fed will move. The firm pointed to an acceleration in AI-related investment and signs of rebounding consumer demand as forces that could keep core inflation above target.
For now, markets are adjusting to the mixed signals: softer monthly core inflation and a drop in the immediate odds of a July hike, counterbalanced by geopolitical risks to energy prices and hawkish remarks from some Fed officials. Those dynamics leave September as the next focal point for traders and policymakers seeking clearer evidence on whether inflation has entered a sustained downtrend.
Context and next steps
- Investors will be watching upcoming monthly inflation readings for confirmation that the June slowdown represents a trend rather than a short-term fluctuation.
- Energy market developments, particularly around the Strait of Hormuz, could rapidly alter inflation expectations and thus policy odds.
- Public testimony from Fed officials in the coming days and additional data releases will be closely parsed for signals about the timing of any future rate moves.