Will tonight at 8:30 PM CPI data embarrass Powell?

The U.S. June CPI data will be released at 20:30 Beijing time on Thursday. Market forecasts generally believe that due to the decline in energy and used car prices, overall CPI inflation in the United States will continue to decrease in June.

U.S. CPI inflation has dropped significantly from the peak of 9.1% reached in 2022. However, the Federal Reserve has stated that it still needs to have more confidence in inflation sustainably moving towards 2% before starting to cut interest rates. Following the positive news from the May CPI report, market observers expect that the latest report will further strengthen the Fed's confidence. José Torres, Senior Economist at Interactive Brokers, optimistically stated: "June will bring good news once again."

According to FactSet's consensus expectations, economists expect the overall CPI in the U.S. to rise by 0.1% month-on-month in June, and the year-on-year rate to decrease from 3.3% to 3.1%. Excluding the more volatile food and energy prices, core inflation is expected to continue to rise slightly. FactSet data shows that analysts expect the core CPI to increase by 0.2% month-on-month in June, with a year-on-year rate of 3.4%. Analysts at Bank of America wrote last week:

"While this number is not as low as May, it will be a good outcome for the Fed."

Analysts pointed out that the reason for the significant difference between core CPI inflation and overall inflation in May was a 2.0% decline in energy prices that month. In contrast, the decline in energy prices in June is limited, so we are unlikely to see a similar significant difference again.

How will key sub-items perform?

In terms of overall CPI inflation, the trend of food prices is worth noting. Several major retailers and fast-food chains announced significant price cuts at the end of May. Over the past four months, food prices purchased in stores have remained stable and have actually decreased by 0.2% since January, but profit margins are still higher than pre-pandemic levels, so there is still room for further price reductions.

Additionally, the growth rate of restaurant food prices may also slow down. Last year, food prices rose by 4.0% year-on-year, far exceeding grocery prices, while the price of food purchased in stores increased by 1.0%. Restaurant prices rose by 0.4% in May, and the increase in June is expected to decrease significantly.

However, Torres expects that food, healthcare, and transportation costs in the U.S. will rise in June. Analysts also expect car insurance prices to continue to rise. At the same time, Torres believes that the decrease in energy costs (including gasoline and aviation fuel) and energy service prices (including electricity) will provide some relief for inflation. He also expects prices for new cars, used cars, and clothing to decreaseAnalysts at Bank of America expect that overall core commodity prices will continue to fall, partly due to the decrease in new car prices. They wrote that the increase in new car inventory is leading manufacturers to offer more discounts and customer incentives. They added that if transportation costs rise in the coming months, core commodity prices may rise again.

The housing component in the CPI (including rental prices and owner's equivalent rent) has been a major driver of overall inflation, and economists expect a certain degree of slowdown in June.

Goldman Sachs analysts stated: "We expect housing inflation to decrease compared to the previous month, with rental inflation dropping to 0.36% and owner's equivalent rent inflation dropping to 0.39%. The gap between rents for new tenants and existing tenants will continue to narrow." Analysts at Bank of America stated that the cooling of rental and owner's equivalent rent inflation in the coming months "should enhance the Fed's confidence in the inflation outlook."

As widely noted by analysts, the CPI reflects housing inflation from leases signed one to two years ago, when a surge in remote work led to a severe housing shortage. The inflation of rental units in the market has now dropped to near zero, indicating that the pace of rental inflation will continue to slow. As rents account for 34.2% of the overall CPI and 43.0% of the core CPI, this slowdown is significant for the CPI measure of inflation.

The Fed has been monitoring the inflation process in non-housing services. Healthcare services account for a quarter of this category in the CPI. In May, healthcare service prices rose by 3.1% year-on-year and 0.3% month-on-month. Before the pandemic, healthcare inflation typically ran about 1.0% higher annually than overall inflation. During the pandemic, its performance lagged behind overall inflation. This type of inflation is still close to 3.0%, meaning that healthcare costs are putting increasing pressure on people's budgets and the economy. The month-on-month increase in June may reach 0.3% again.

When will the Fed cut interest rates?

Although Fed officials acknowledge that recent inflation has made more progress, they insist that they still need more confidence in cooling inflation before starting to cut rates.

This week, Fed Chairman Powell admitted during a congressional hearing that recent data has made "modest further progress," but he stated that more progress is needed. He said, "More good data will enhance our confidence in continuing towards 2% inflation." He added that the Federal Open Market Committee (FOMC) will continue to "make decisions at successive meetings." As for the timing of rate cuts, he still did not provide a specific viewpoint.

According to the CME FedWatch tool, the bond futures market expects a 68% probability of a 25 basis point rate cut by the Fed in September, with a 95.3% probability of keeping rates unchanged in August and only a 4.7% probability of a rate cutThey almost unanimously expect the Federal Reserve to keep interest rates unchanged at its meeting later this month.