Following the release of the US June CPI data, interest rate markets quickly scaled back bets on a July rate hike, US Treasuries rebounded, US stocks rose, and crypto assets also gained a short-term respite.
Data released by the US Bureau of Labor Statistics on July 14th showed that the seasonally adjusted June CPI fell 0.4% month-on-month, with the year-on-year rate dropping to 3.5% from 4.2% in May. Core CPI, which excludes food and energy, was flat month-on-month, and the year-on-year rate decreased to 2.6% from 2.9%. For traders, this data directly raised the bar for the Federal Reserve to continue raising interest rates in July.
On the same day, in congressional testimony, Federal Reserve Chair Kevin Warsh emphasized that the FOMC has 'no tolerance for sustained high inflation.' He did not provide a signal for the next policy step, nor did he hint that a single month of low inflation is enough to confirm a policy pivot.
The market's trading divergence is now clear. Is the June CPI a policy turning point, or just a temporary cooling driven by gasoline prices?
Low CPI Gives the Market a Window to Skip a Rate Hike
General investors should first distinguish between the two CPI measures. Headline CPI includes more volatile items like gasoline and food, directly impacting the inflation number seen by the market. Core CPI excludes food and energy, providing a closer gauge of the underlying inflation pressures the Fed monitors.
The reason the June data prompted immediate market action is that both readings were favorable. The headline CPI turning negative month-on-month indicates a clear easing of price pressures for that month. Core CPI being flat month-on-month also alleviated concerns about 'energy prices falling but service prices remaining sticky.'
This data interrupted the rate hike narrative of the previous weeks. AP reported that after the CPI release, traders saw the probability of a July rate hike drop to below 17%, compared to about 42% the day before. The yield on the 10-year US Treasury note also fell from Monday's 4.62% to 4.58%.
This market move was not driven by a reassessment of improving corporate profits, but by a change in the expected path of interest rates. US Treasuries benefited most directly because reduced rate hike risk pushes yields lower. Growth stocks and crypto assets are more sensitive to discount rates and thus more prone to rebound when interest rate pressure eases.
Therefore, the market reaction has its rationale. At least from a single month's data, there is no urgent need for the Fed to hit the brakes again in July.
Warsh Gave No Signal of a Policy Shift
Warsh's testimony was important, not only because of its relatively hawkish tone but also because it was an opportunity for the new Chair to establish policy credibility before Congress.
His core stance was straightforward. The Fed will not tolerate sustained high inflation, nor will it abandon its anti-inflation posture because of one favorable CPI report. More accurately understood, the June data reduced near-term rate hike pressure but cannot be automatically converted into a signal of easing.
This does not conflict with the futures market reaction. Traders are pricing the probability of the next meeting, while Warsh is preserving the Fed's policy optionality for the coming months. The former can adjust quickly based on a single data point; the latter cannot let the public believe the Fed has already let its guard down.
The June FOMC meeting just maintained the federal funds target range at 3.50%-3.75%. The June economic projections showed a median federal funds rate of 3.8% by the end of 2026, slightly above the midpoint of the current range. If Warsh turned dovish after a single month's CPI, it would instead undermine the credibility of 'price stability first.'
The more appropriate current framing is not that the Fed has pivoted to easing, but that the threshold for a July rate hike has been raised. This distinction will determine how far the risk asset rebound can go.
Gasoline and Rent Determine the Data's Substance
The biggest highlight of the June CPI was energy, and the biggest uncertainty also lies with energy.
The data showed the energy index fell 5.7% month-on-month, with gasoline prices dropping 9.7% month-on-month. According to the BLS methodology, falling energy prices were the largest contributor to the monthly decline in headline CPI, offsetting increases in shelter and food prices.
The problem is that gasoline prices are highly volatile. They can deliver short-term inflation surprises but can also rebound quickly due to geopolitical risks or supply disruptions. If oil prices resume their upward trend, market optimism over the June data will be dampened.
Shelter costs are another key detail. Shelter costs rose 0.1% month-on-month in June, the smallest monthly increase since January 2021. Rent and owners' equivalent rent carry high weight in the CPI. If this component continues to slow, the decline in core inflation will be more sustainable.
But a single month's rent reading cannot yet prove a trend is complete. Service inflation is typically slower and stickier than gasoline inflation. If wage growth does not cool down in tandem, businesses may still pass costs on to consumers. The market is now buying the possibility that the slow variables are starting to loosen, not a result already delivered.
The Rebound Needs More Data to Follow
For trading, the short-term conclusion is clearest. The risk of a July rate hike has decreased significantly, giving risk assets a reasonable window to rebound. But this window is not indefinite; it requires subsequent data to continue providing proof.
If oil prices rise again due to geopolitical risks, the optimism brought by June's headline CPI will be quickly diluted. Energy prices may not directly change core CPI, but they affect inflation expectations and could reignite the Fed's vigilance against a resurgence of inflation.
If core services, wages, and rent do not continue to cool down, Warsh's caution will regain the upper hand. The market may then realize that the June CPI merely pushed the July rate hike risk further out, rather than completely eliminating the tightening risk for the year.
For bonds and risk assets to continue pricing in easing, they need several consecutive months proving that inflationary pressures are receding from energy to services. Until then, this rebound looks more like a trade on reduced rate hike risk, not yet a confirmation of an easing cycle.
