U.S. rate traders pare July hike bets after inflation cools

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U.S. rate traders pare July hike bets

Highlights

Consumer Price Index rises 3.5% year on year in June, down from 4.2% in May, with core CPI steady at 2.6%, softening inflation concerns.
Traders cut probability of a July 28-29 Fed rate hike to 10% from 35%, and September hike odds to 60% from over 90% after CPI data.
Fed remains cautious as Chairman Kevin Warsh reiterates commitment to fighting inflation, while Capital Economics expects eventual rate hike due to AI boom and demand rebound.

June inflation data reshapes Fed timing outlook

As reported by Reuters, citing the U.S. Bureau of Labor Statistics, the Consumer Price Index rises 3.5% in the 12 months through June after climbing 4.2% in May, while core CPI, excluding food and energy, increases 2.6% year on year after 2.9% in May. On a monthly basis, core CPI is unchanged, a reading that analysts view as a gauge of underlying inflation pressure.

The softer figures ease some concern inside the Federal Reserve that higher oil prices linked to months of conflict in the Middle East are feeding more persistent inflation. Oil prices cool in June as the U.S. and Iran hold peace talks, but they rise sharply again in recent days after hostilities around the Strait of Hormuz reignite.

Before the inflation report, Fed Governor Christopher Waller says the central bank may need to raise rates in the near term if core inflation stays hot. He also says he needs to see several months of cooler inflation data to be comfortable with not raising rates at all, and his comments are often watched closely as a signal of shifts in Fed thinking.

Market pricing and policy signals remain cautious

Traders now see about a 10% chance of a quarter-percentage-point increase at the Fed's July 28-29 meeting, down from 35% before the CPI release, according to Fed funds futures prices traded at CME Group. For the September 15-16 meeting, markets price in roughly a 60% chance of a hike, down from more than 90% before the data.

Fed Chairman Kevin Warsh is scheduled to begin two days of testimony in Congress later Tuesday and is set to tell the U.S. House of Representatives Financial Services Committee that the central bank has no tolerance for persistently elevated inflation, according to prepared remarks. That keeps the policy debate focused on whether softer price data marks a durable turn or only a temporary pause in inflation pressures.

Capital Economics says it still expects the Fed to raise interest rates eventually, arguing the question is when rather than if. The firm points to the AI investment boom and signs of rebounding consumer demand as factors likely to keep core inflation above the central bank's target.

In our earlier coverage of the June U.S. CPI slowdown, we explained that inflation eased more than expected as gasoline prices briefly retreated, even as renewed fighting around the Strait of Hormuz quickly pushed fuel costs higher again. We also noted that this energy-price reversal can keep inflation expectations elevated and complicate the Federal Reserve’s interest-rate outlook, with markets adjusting the odds of a hike around upcoming meetings.

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