The CPI has reduced the interest rate hike risk for July, but the expectation has not disappeared.

TL;DR

· U.S. June CPI came in below expectations, prompting traders to lower their bets on a July rate hike.

· The main driver was a decrease in energy prices, while a slowdown in housing costs inflation increased the significance of the data.

· Related assets: U.S. Treasuries, U.S. Dollar Index, growth stocks, BTC, ETH, crude oil.

Following the release of the U.S. June CPI, the interest rate market quickly scaled back expectations for a July rate hike, leading to a rebound in U.S. Treasuries, a rise in U.S. stocks, and a brief recovery in crypto assets.

Data released by the U.S. Bureau of Labor Statistics on July 14th showed that the June CPI, seasonally adjusted, declined by 0.4% month-over-month, dropping from 4.2% in May to 3.5% year-over-year. The core CPI, which excludes food and energy, remained unchanged month-over-month and decreased from 2.9% to 2.6% year-over-year. For traders, this set of data raised the bar for a continued Fed rate hike in July.

On the same day, Federal Reserve Chair Kevin Warsh emphasized in congressional testimony that the FOMC has "zero tolerance for sustained high inflation." He did not provide a signal on the next policy move, nor did he suggest that a single month of low inflation would be sufficient to signal a change in policy.

The market is now clearly divided in its trading stance. Is the June CPI a policy inflection point, or merely a temporary cooling off due to gasoline prices?

The Low CPI Has Given the Market a No-Rate-Hike Window

First, retail investors need to distinguish between the two CPI measures. The headline CPI includes volatile items such as gasoline and food, directly impacting the inflation figures seen by the market. The core CPI, which excludes food and energy, provides a closer look at the Fed's gauge of underlying inflationary pressures.

The reason the market acted swiftly to the June data is that both readings were positive. The headline CPI turned negative on a monthly basis, indicating a significant easing of price pressures that month. The core CPI remained flat on a monthly basis, alleviating concerns about the previous narrative of "energy prices falling but service prices remaining sticky."

This data disrupted the narrative of a rate hike in the preceding weeks. According to the AP, following the CPI release, traders estimated the probability of a July rate hike had dropped to below 17%, down from around 42% the previous day. The 10-year U.S. Treasury yield also fell from 4.62% on Monday to 4.58%.

This round of market rally was not driven by a reassessment of corporate earnings but by a shift in interest rate expectations. The U.S. Treasury bonds benefited most directly, as the reduced rate hike risk pushed yields lower. Growth stocks and crypto assets are more sensitive to discount rates and are also more likely to rebound when interest rate pressure eases.

Therefore, the market reaction is reasonable. At least from the data of a single month, the Fed does not need to rush to tap the brakes again in July.

Warsh Did Not Signal a Market Turnaround

Warsh's testimony is important not only because of its hawkish tone but also because this is a moment for the new chair to establish policy credibility before Congress.

His core stance is straightforward. The Fed will not tolerate persistent high inflation, nor will it abandon its anti-inflation stance simply because of a rosy CPI report. A more accurate understanding is that the June data reduced the immediate pressure for a rate hike, but that does not automatically translate into a dovish signal.

This is not in conflict with the futures market reaction. Traders are trading on the probability of the next meeting, while Warsh is maintaining policy flexibility for the coming months. The former can adjust quickly based on a data point, but the latter cannot lead the public to believe that the Fed has relaxed its vigilance.

The June FOMC just kept the federal funds target range at 3.50%-3.75%. The June economic forecasts show a median federal funds rate of 3.8% by the end of 2026, slightly above the current midpoint of the range. If Warsh turns dovish after a single month's CPI report, he would weaken the credibility of "price stability first."

The more appropriate description at the moment is not that the Fed is shifting to a dovish stance, but that the threshold for a July rate hike has been raised. This difference will determine how far the rebound in risk assets can go.

Gasoline and Rent Drive Data Significance

The highlight of the June CPI was in energy, while the greatest uncertainty also lies in energy.

The data shows that the energy index fell by 5.7% month-on-month, with gasoline prices dropping by 9.7%. According to the BLS methodology, the energy price decline was the largest contributing factor to the overall monthly decrease in CPI, offsetting increases in housing and food prices.

The issue lies in the significant volatility of gasoline prices. It can bring short-term inflation surprises, but it can also quickly rebound in the face of geopolitical risks or supply disruptions. If oil prices resume their upward trend, the market's optimism about the June data will be weakened.

Housing costs are another key detail. Housing costs rose by 0.1% month-on-month in June, marking the smallest monthly increase since January 2021. Rental and owner's equivalent rent carry significant weight in the CPI; if this subcomponent continues to slow down, the downward pressure on core inflation will become more sustained.

However, a single-month rent reading does not prove that the trend is complete. Service inflation typically lags and is stickier than gasoline. If wage growth does not cool concurrently, businesses may still pass on costs to consumers. The market is now pricing in the possibility of the start of a loosening in a slow variable, not a realized outcome.

A Rebound Requires More Data Relay

For trading, short-term conclusions are most clear. The risk of a July rate hike has significantly diminished, giving risk assets a reasonable rebound window. However, this window is not indefinite; it requires follow-up data to continue proving itself.

If oil prices resume their uptrend due to geopolitical risks, the optimism brought by the overall June CPI will be quickly diluted. Energy prices may not directly alter core CPI, but they will affect inflation expectations and reignite the Fed's vigilance against secondary inflation.

If core services, wages, and rent do not continue to cool in the next data releases, Warsh's caution will once again take the lead. At that point, the market may realize that the June CPI simply pushed back the risk of a July rate hike rather than completely eliminating the tightening risk for the year.

Bonds and risk assets need to continue pricing in accommodation, requiring several more months of evidence showing inflation pressure transitioning from the energy side to the service side. Until then, this rebound resembles more of a trade on reduced rate hike risk rather than a confirmation of a loose cycle.

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