US CPI data provides a welcome, but temporary, sigh of relief

A decline in energy prices and the ongoing unwind of tariff-related price impacts drove a slowdown in prices in June. Headline inflation declined by 0.4% in the month, bringing the annual rate down to 3.5%, a much lower reading than expected. Underlying core inflation was unchanged in June, lowering the annual rate to 2.6%. While today’s data is a welcome relief for markets and policymakers, the ongoing volatility in oil prices increases the risk that this respite may be short-lived. 

Report details

• Headline inflation decreased 0.4% in June, marking the largest monthly decline since April 2020. The decrease brought the annual rate to 3.5%, down sharply from last month’s uncomfortably high level of 4.2%. Evidence of broader second-round effects on inflation also remains limited, suggesting the report should be a welcome relief to markets and policymakers.
• Even so, as energy was the single largest driver of the monthly decline in prices, the sharp cooldown in inflation largely reflects the ongoing volatility in global crude oil prices. Given the fluid nature of the Middle East conflict, this relief may be temporary.
• Food prices edged up slightly but remained contained, with four of the six major grocery categories posting gains, matching last month’s figure. However, the risk remains that a prolonged disruption to shipping through the Strait of Hormuz could further raise fertilizer costs and ultimately put upward pressure on food prices.
• Core inflation, which excludes food and energy, was unchanged in the month, below expectations for a 0.2% increase. Importantly, the annual rate slowed to 2.6%, from 2.9% prior. Largely constrained by core services, the weakness was driven by the continued cooling of shelter costs—the smallest one-month change since January 2021—amid the ongoing slowdown in owner’s equivalent rent. Declining shelter inflation was also undercut by a significant decline in hotel prices, representing an earlier-than-anticipated unwind of the tourism boost expected from the World Cup. Within transportation, prices declined for a second consecutive month, driven by lower motor vehicle insurance premiums. Airline fares, on the other hand, posted a modest increase, slowing from last month’s pace but still up almost 30% from a year ago.
• Core goods prices continued to decline as last year’s tariff impact has gradually unwound. Indeed, the softness was broad-based across tariff-sensitive categories, with apparel, household furnishings and supplies, and transportation commodities all seeing declines. Meanwhile, technology-related products also saw price cuts, though it may only be a matter of time until prices reaccelerate as the impact of the AI capex boom drives up costs of semiconductors and memory chips, key inputs for these products.
• The Fed’s preferred supercore inflation measure rose 0.2%, the smallest increase since May 2020, bringing the annual rate to 3.2%, from 3.7%. Serving as a measure of wage-driven inflation, the data imply that while wage pressures remain sticky, they have not yet shown signs of reacceleration despite the energy shock, helping keep broader inflationary pressures contained.

Policy outlook

Today’s downside inflation surprise will be a welcome relief for both markets and the Fed. Headline inflation posted its largest monthly decline since April 2020. Underlying price pressures also eased, with shelter inflation slowing to its weakest monthly pace since 2021. The unwinding tariff-related cost pressures, together with the absence of broader second-round effects from the conflict, at least thus far, minimize the risks of runaway inflation. However, investors should be cautious about extrapolating this weakness too far. The rebound in energy prices over the past week suggests some of this relief may already prove short-lived.

At his Congressional testimony today, Chair Warsh once again provided little policy guidance, but today’s data all but rules out a July rate hike. Beyond that, the outlook is less certain. Resurgent energy prices, growing focus on the inflationary effects of the AI capex boom, and Warsh’s re-emphasized intolerance for elevated inflation, suggest the risk of a rate hike this year is very much alive.