Inflation Cooled More Than Expected. Traders Now Think the Fed Will Hold Rates Steady in July

Financial markets sharply reduced expectations that the Federal Reserve will raise interest rates later this month after new government data showed inflation eased more than economists anticipated in June.

According to data released Tuesday by the U.S. Bureau of Labor Statistics, the Consumer Price Index (CPI) rose 3.5% over the past 12 months through June, slowing from the 4.2% annual increase recorded in May. While inflation remains above the Federal Reserve's long-term 2% target, the report suggested that the pace of price increases is cooling.

Even more encouraging for policymakers was the performance of core inflation, which excludes the more volatile food and energy categories. Core CPI rose 2.6% year over year in June, down from 2.9% in May, while remaining unchanged on a monthly basis. Economists closely monitor core inflation because it is viewed as a better indicator of underlying price trends.

The softer-than-expected inflation report immediately reshaped market expectations for the Federal Reserve's next policy meeting. According to CME Group's FedWatch, traders now assign only about a 10% probability that the central bank will raise its benchmark interest rate at its July 28-29 meeting. Before the inflation report was released, markets had priced in roughly a 35% chance of another quarter-point increase.

Expectations for September also eased considerably. Investors now see approximately a 60% chance of a rate hike at the Fed's Sept. 15-16 meeting, down from more than 90% before Tuesday's data.

The report offers some relief for Federal Reserve officials who have been watching whether rising oil prices could once again fuel broader inflation throughout the economy.
Energy markets have remained volatile in recent months.

Oil prices softened during June as diplomatic talks between the United States and Iran temporarily reduced tensions. However, prices have climbed again in recent days after renewed hostilities around the Strait of Hormuz, one of the world's most strategically important shipping routes.

Before the conflict that erupted earlier this year, roughly one-fifth of the world's crude oil supply moved through the waterway. Those concerns were echoed Monday by Federal Reserve Governor Christopher Waller, who warned that policymakers could still need to raise interest rates in the near future if underlying inflation remained elevated.

Waller said he would need to see several consecutive months of cooler core inflation before becoming confident that additional rate hikes would not be necessary. While he stressed that his comments reflected his own views rather than official Fed policy, investors often view his remarks as an important signal of the central bank's evolving thinking.

Attention now shifts to Federal Reserve Chairman Kevin Warsh, who is scheduled to begin two days of testimony before Congress. In prepared remarks for the House Financial Services Committee, Warsh emphasizes that the central bank has "no tolerance" for persistently elevated inflation, reinforcing the Fed's commitment to restoring price stability even as recent data point to improvement.

Despite Tuesday's encouraging inflation report, many economists believe the Federal Reserve has not yet finished tightening monetary policy. Analysts at Capital Economics cited by Reuters argued that the latest numbers may delay action rather than eliminate it.

"We still think it's a matter of when, rather than if, the Fed will raise interest rates," the firm wrote, pointing to strong business investment in artificial intelligence and signs that consumer demand is strengthening again. Those factors, analysts say, could keep core inflation above the Fed's target in the months ahead.