Soft Reading on Inflation Strengthens the Case for September Rate Cut

The June Consumer Price Index report came in cooler than expected on Thursday, cementing investor hopes that the Federal Reserve will cut interest rates before the third quarter is over.

The Bureau of Labor Statistics reported that the CPI climbed 3.0% in June from year-ago levels—a decrease from May’s 3.3% rate—and declined 0.1% from the previous month. Core CPI, which excludes volatile food and energy prices, rose 3.3% on an annual basis and 0.1% in the June report.

That’s good news for investors anxiously awaiting the end of the central bank’s historic tightening cycle. Since the start of the year, Fed officials have maintained that they are seeking more confidence that inflation is under control before they move to cut rates. Analysts say June’s inflation data will help bolster that confidence and open the door for looser policy.

“Today’s news signals that inflation is normalizing and solidifies the case for a Fed rate cut in September,” says Morningstar chief US economist Preston Caldwell.

June CPI Report Key Stats

• CPI decreased 0.1% after being unchanged in May.
• Core CPI climbed 0.1% after rising by 0.2% in May.
• CPI increased 3.0% year over year after growing by 3.3% the prior month.
• Core CPI rose 3.3% from year-ago levels after growing 3.4% in May.

Caldwell points to lower services inflation across the board in June’s data, including in the daycare, vet services, and cellular and internet services categories. He adds that the cooler-than-expected report benefited from a few unusual factors “unlikely to repeat in coming months.” On a monthly basis, airfare prices dropped 5.0%, hotel prices dropped 2.0%, and used car prices dropped 1.5%.

“The next few months of CPI data are highly unlikely to be as good as today’s extremely low result,” he says, though he also anticipates that used car prices will keep dropping. “We expect to see continued downward pressure on used car prices, but not to the same degree as this month.”

Shelter Inflation is Finally Falling

Shelter inflation, which is also included in the services category, finally eased in June. High rent prices and equivalent costs for homeowners have been among the most persistent drivers of elevated inflation for months but now, the trend is beginning to reverse.

“Perhaps the best news—though not unexpected—was shelter inflation falling to 0.2% month over month,” Caldwell says. “Housing has been the last shoe to drop in terms of winning the battle against high inflation. Leading-edge data has strongly indicated for some time now that a fall in housing inflation was in the works.”

Goods Inflation Slightly Elevated

Concerning goods inflation, Caldwell says prices outside vehicles were slightly elevated in June, the “one area of concern” within an otherwise good report. Durable goods prices excluding cars rose 0.3% on a monthly basis, but a persistent trend of disinflation within the category means they’re still down 3.9% on a three-month annualized basis. In the core category, nondurable goods rose 0.4% on a monthly basis. Durable goods include longer-lasting purchases like electronics, appliances, toys, and sports equipment.

Will the Fed Cut Rates in September?

Bond futures traders now see a roughly 85% chance that the Fed will cut its target rate by 0.25% at its September meeting, according to the CME Fedwatch tool. A month ago, traders were pricing in odds of less than 50% for a September cut.

Caldwell’s base case is also a September rate cut, though he notes that producer price data scheduled for release on Friday will shed light on the Fed’s preferred measure of inflation: the Personal Consumption Expenditures Index.

Despite the recent overall cooling in economic data, Caldwell says, “it still seems unlikely the Fed would jump into a rate cut for its July meeting without any prior guidance. There are early signs of weakening economic growth, but alarm signs aren’t flashing.”