An unexpected cooling in US inflation sparks a rebound in US bonds, and the market withdraws bets on the Federal Reserve's July interest rate hike

The Zhitong Finance App learned that the US inflation data for June unexpectedly cooled down sharply, prompting the market to quickly adjust expectations for the Federal Reserve's monetary policy. US Treasury bonds rose sharply on Tuesday, and traders have withdrawn their bets on the Federal Reserve's fastest rate hike in July and postponed expectations of interest rate hikes until September or October.

According to data released by the US Department of Labor on the same day, the US consumer price index (CPI) fell 0.4% month-on-month in June, the first monthly decline since 2020. The decline was also significantly better than market expectations. After this data was released, the market generally believed that the Federal Reserve would have more time to observe the inflation trend without taking action to raise interest rates this month.

Affected by this, the price of US Treasury bonds rose across the board. Among them, the 2-year US bond yield, which is most sensitive to monetary policy, once fell 14 basis points to 4.14%, the biggest one-day decline since August last year. Some of the declines narrowed thereafter, and still fell by about 10 basis points at the end of the session. At the same time, the three major US stock indexes generally rose, and the US dollar weakened against major currencies across the board.

Zach Griffiths, head of investment-grade bonds and macro strategy at CreditSights, said: “The inflation data released today basically rules out the possibility that the Federal Reserve will raise interest rates in July. Although inflation is still above target and the situation in the Middle East continues to deteriorate, this data is enough for the Federal Reserve to continue to wait and see.”

However, later in the day, Federal Reserve Chairman Kevin Walsh continued to send hawkish signals during congressional hearings, narrowing the bond market's rise somewhat.

Walsh said that the Federal Reserve will remain committed to the goal of reducing inflation to 2%, and stressed that the problem cannot be considered solved because of the improvement in monthly inflation data.

Despite this, the market still generally expects that the Federal Reserve will keep the federal funds rate target range unchanged at 3.50% to 3.75% at the interest rate meeting to be held on July 29.

The data showed that after excluding food and energy prices, the core CPI unexpectedly remained flat month-on-month in June, further mitigating market concerns about continued warming inflation.

Tracy Chen, portfolio manager at Brandywine Global Investment Management, said that the latest inflation data will ease the pressure on the Federal Reserve to raise interest rates this year, but as the situation in Iran continues to be tense, the market is still not completely free from risk.

In fact, the recent conflict in the Middle East once significantly boosted market expectations for interest rate hikes. Since the conflict between the US and Iran escalated at the end of February this year, international oil prices have continued to rise. Investors are worried that rising energy prices will push up inflation again and force the Federal Reserve to further tighten monetary policy.

In particular, after Federal Reserve Chairman Walsh presided over the interest rate meeting for the first time last month, many officials made hawkish speeches one after another. The market once anticipated that the Fed might resume raising interest rates in July as soon as possible.

On Monday, Federal Reserve Governor Christopher Waller said that if the inflation data is “hot” again, a “near future” rate hike should be considered. Affected by this, the interest rate futures market once reflected a probability of 25 basis points of interest rate hike in July close to 50%.

However, with the release of the latest CPI data, the market quickly adjusted expectations. Currently, traders generally expect that the Federal Reserve is more likely to raise interest rates next in September or October.

It is worth noting that although the current inflation data is better than expected, the market believes that there is still a repeated risk of future inflation. Affected by renewed tension in the Strait of Hormuz, the price of Brent crude oil has rebounded to around 85 US dollars per barrel, up nearly 20% from the low at the beginning of this month. Higher energy prices may once again push inflationary pressure.

Tiffany Wilding, an economist at Pacific Investment Management, said that the latest inflation data has undoubtedly given many Fed officials a sigh of relief. Although it will not completely close the door to future interest rate hikes, it at least provides more room for the Federal Reserve to continue to wait and see.