CPI cools down significantly! Waller isn’t buying it?

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June CPI & Federal Reserve

The US June CPI increased by 3.5% year-on-year, with a month-on-month decrease of 0.42%. Core CPI rose by 2.6% year-on-year, with a slight month-on-month decrease of about 0.02%. Overall, core services did not continue to rise and energy saw a significant cooling off. These two factors were the biggest drivers for the decline in June inflation and they lay the foundation for continued disinflation.

First, let's look at the most important part: core services. Core services rose by only about 0.02% month-on-month. Among them, the largest weighted segment, housing rent, saw a 0.04% month-on-month increase in June, but this is much lower compared to 0.11% in May and 0.21% in April. This shows that housing rent validates my analysis from May's PCE report – at the very least, it is no longer persistently dragging down CPI improvements, which is very important.

The second most heavily weighted category in core services is medical care services. After surging in May, this segment cooled slightly in June month-on-month. The net change was very noticeable, making a significant contribution to the overall CPI and the cooling of services categories.

The third and fourth heaviest categories in core services are transportation and education/communications, respectively. Both of these categories recorded a month-on-month decrease in June. Among them, auto insurance and mobile phone fees saw significant drops.

So when it comes to the sticky service categories, the heavier-weighted segments, such as housing and healthcare, as well as those with less weight, including education/communications and transportation, are all cooling. This provides favorable data to support expectations of inflation continuing to fall.

Next, let’s look at the trend of core goods prices, which are more sensitive to tariffs and wars.

First, core goods prices overall continued the cooling trend we’ve seen since May. Within this, the largest net changes were in apparel and entertainment goods.

Specifically, apparel went from rising to falling month-on-month, with a net change of 0.02%, a significant cooling. The main drivers were declines in prices for men's clothing, footwear, and jewelry/watches.

Another segment, entertainment goods, also had a similar net change of around 0.02%, but in the opposite direction—it went from falling prices to a month-on-month increase, mainly driven by pet supplies and toys.

Objectively speaking, these two sub-categories are greatly affected by tariffs, but since one rose and one fell, they essentially cancel each other out. In addition, given their low weight, I believe their overall impact is limited, so just use this for reference.

So overall, June CPI continues May’s strong PCE trend—it's quite impressive. After the data release, the probability of a rate hike in July shifted dramatically from about even yesterday to a 91% chance of no action, with bets on the Federal Reserve standing pat in July. However, in December, the probability of a rate hike still remains above 80%. This means that the Fed is not ruling out rate hikes; rather, it may delay hiking until September or October in order to accelerate the cooling of inflation.

This raises a question: Isn't inflation improving? Why does the Federal Reserve still plan to raise rates?

Indeed, inflation is improving, but it’s still far from the Fed’s 2% statutory target. Moreover, high inflation in the US has persisted for years, and Congress maintains skepticism toward the Fed's dual mandate of price stability and full employment.

Just today, at a congressional hearing, Waller reiterated the Fed’s zero-tolerance stance on inflation. He emphasized that the Fed will use its tools to achieve price stability, pledging to break sticky prices and bring them back to the 2% target.

As for Waller's stance, Jason tends to believe that there is still a possibility for a rate hike by the Fed this year. However, as long as inflation continues to improve and cool down as it is now, at the very least, it could reduce the number and magnitude of rate hikes. In this scenario, inflation could quickly cool to the target range, giving the Fed data to support potentially restarting an easing policy next year. Both the stock and bond markets could develop more sustainably and healthily, rather than, as they are now, remaining under the shadow of a risk for years.

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