Today’s June Inflation report came in below economists’ consensus forecasts for both headline and core, sending stocks solidly higher this morning as investors were quite pleased with the report. Although we expect the Federal Reserve (Fed) to raise rates during this month’s Federal Open Market Committee (FOMC) meeting on July 25-26, further evidence of ebbing inflation pressure increase the chances that this month marks the last hike of this Fed rate hiking cycle.
Overview
- Consumer prices rose 0.2% in June, pushing the annual rate of inflation down to 3.0%, the lowest annual rate since March 2021.
- More importantly, inflation, excluding food and energy rose 0.2% in June, the smallest monthly gain since August 2021.
- The largest contributor to the monthly increase in prices was shelter costs, accounting for over 70% of the increase this month.
- Grocery prices were unchanged in June, providing a bit of a reprieve for lower income households; however, more consumers are eating out.
- The overall theme in recent months has been strong consumer demand for experiences over material goods and we are seeing that play out in consumer pricing dynamics.
Rents Plummet but Shelter Costs Are the Largest Increase
Inflation in 2023 has been significantly impacted by the housing sector. It is anticipated that housing costs, which account for a sizable portion of the CPI, will decline. The reason for this is that there has been an increase in development, particularly of multi-family homes, which should help lessen the pressure on rents. Although we are aware that lower rents will take some time to flow through to the official inflation measurements, the decline is favorable for inflation rates in the months to come. Investors and policymakers alike should prepare for a decrease in housing-related inflation in coming months.
With the most recent CPI statistics, we have updated our inflation dashboard, which is intended to give a quick overview of the inflationary climate. Housing costs, which contributed over 70% of this month’s increase, remain a key sticking point as the Fed continue its effort to bring broad inflation down toward its 2% goal.
Restaurants Order up Rising Prices amid Increasing Demand
Prices at restaurants are still rising at a fast clip, indicating that consumer demand is still strong for restaurant service. The overall theme in recent months has been a strong consumer demand for experiences over stuff and we are seeing that play out in consumer pricing dynamics in this and other industries.
The encouraging trend in consumer prices in recent months will provide additional fodder for markets to debate the terminal fed funds rate. Overall, the deceleration in core prices will be happily received by investors. Yields on the 2-year Treasury fell over 10 basis points (0.10%) on the news. This supports our view that bond yields will likely be lower by the end of this year.
What Does This Mean for the Next FOMC Meeting?
During last month’s Congressional testimony, Chairman Jerome Powell discussed concerns over core inflation or the “core services ex-shelter” basis. Inflation is improving in these areas, but are still above the Fed’s goal. Market participants believe that there is more than a 90% chance that the Fed will raise rates by 0.25% at its meeting later this month, according to CME’s FedWatch tool.
Today’s CPI data does not change our expectation that the Fed will hike in a few weeks. But it does lower the probability of an additional hike later this year. Whether we get one more hike or two, we believe that the Fed will begin pulling back on its monetary policy levels as inflation comes down further and employment slows later this year and into early 2024. A shift in policy direction will likely please stock and bond markets.
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