US CPI unexpectedly cooled down in June! The probability that the Federal Reserve will raise interest rates in July is low, and US stocks may usher in “timely rain”

The Zhitong Finance App learned that data released on Tuesday showed that the US consumer price index (CPI) rose 3.5% year on year in June, lower than market expectations of 3.8%, and clearly down from the previous value of 4.2%; it fell 0.4% month-on-month, the first month-on-month decline in six years. The core CPI excluding energy and food rose 2.6% year over year, which was also lower than market expectations of 2.8%; the month-on-month increase was 0%, which is a significant decrease from the previous value of 0.2%.

This better-than-expected inflation data cooled the market's expectations of the Fed's interest rate hike. Traders have lowered their bets on the Federal Reserve's July rate hike. Currently, the market anticipates that the probability that the Federal Reserve will raise interest rates by 25 basis points at the July 28-29 meeting has dropped from 35% previously to about 15%. At the same time, the expected probability of interest rate hikes in September has also declined. Currently, it is about 70%, which is lower than the previous level of more than 90%.

Market analysts believe that weakening inflation has weakened the urgency of the Federal Reserve to further tighten monetary policy in the short term, driving up market risk appetite. On Tuesday, the three major US stock indices collectively closed higher, and semiconductor, storage, and optical communication concept stocks strengthened across the board. US Treasury bonds also rose. 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.

Zach Griffiths, head of investment-grade bonds and macro strategy at CreditSights, said: “The inflation data released on Tuesday basically ruled out the possibility of the Federal Reserve raising 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.”

Justin Wolvers, an economics professor at the University of Michigan, also said, “The more moderate inflation report released on Tuesday reduced the pressure on the Federal Reserve to raise interest rates further. The Fed's next move is likely to be to raise interest rates, but future rate hikes may be later or less severe than many people worry.” However, at the same time, he warned: “Now that we have entered July, international oil prices have risen again, which has raised questions in the market about how long this easing of inflation will last.”

Some strategists pointed out that the cooling of the US CPI data for June changed the market focus from the two major macro risks that previously dominated the market, rising oil prices and expectations of interest rate hikes in July, to individual stock earnings reports at the micro level.

Chris Liu, head of the DIY Value Investing portfolio, pointed out that weak inflation data quickly had an impact on the market, and “the market raised its bets on the Federal Reserve keeping interest rates unchanged, albeit by a small margin.” He also pointed out that there was also a clear sector rotation in the US stock market on Tuesday. IBM (IBM.US) issued an early warning that performance fell short of expectations, “once again triggering the withdrawal of funds from the software sector.” Meanwhile, investors are turning back to technology hardware stocks, including SK Hynix (SKHY.US), Micron (MU.US), SanDisk (SNDK.US), and Nvidia (NVDA.US). Server vendors Dell Technologies (DELL.US) and HPE (HPE.US) “also experienced a strong rebound.”

Julian Timmer, head of global macro at Fidelity Investments, analyzed market fundamentals from a broader perspective. He said, “As long as fundamentals still support current trends, a sharp shock in short-term capital will not end the bull market, and at present, it seems that fundamentals still provide support.” Timmer suggests investors adopt a “barbell strategy”, that is, holding AI and growth stocks on the one hand, and hedging by allocating stocks with stable return attributes outside the AI field. However, he also pointed out that currently the market's implied inflation forecast is only 2.26%. “This level is too low in my opinion.”

It is worth mentioning that Federal Reserve Chairman Walsh said in his written testimony to the House Financial Services Committee on Tuesday: “Committee members have no tolerance for continued high inflation, and we have made a firm commitment to restore price stability.” He stressed that monetary policy is currently a top priority. If the Federal Reserve gets the policy right, the sharp rise in inflation over the past five years will be a thing of the past.

Regarding the CPI data released on Tuesday, Walsh said, “Although the CPI data released this morning performed better than expected, I don't agree with the selective interpretation of the data. I think there's still a lot of work to be done.”

At the hearing, Walsh made it clear that if pressured by US President Trump, he would “do his job well” and that even if criticized by Trump, he would act on the data. This is Walsh's most direct comment to date on Trump's challenge to the Federal Reserve.

Nick Timiraos, known as the “Federal Reserve's microphone,” wrote that Walsh reiterated the Fed's goal of controlling inflation, but did not suggest interest rate trends, and did not talk too much about his views on interest rates during the hearing. This is in line with his consistent assertion that the Fed should not disclose next steps in advance, nor has he clearly defined the criteria for judging the evolution of high inflation into sustained inflation.

Walsh's statement about his determination to curb inflation may help stabilize inflation expectations. Chuck Carlson, CEO of Horizon Investment Services, said, “Walsh's message is, 'We can reduce inflation', and this is exactly what his audience wants to hear. Maybe inflation can fall back naturally without raising interest rates again.”