Key US inflation indicators slowing down, market has priced in more than two rate cuts this year!

The long-awaited cooling of housing inflation has finally arrived, with the US core CPI in June hitting a new low in over three years. This signal provides a strong basis for the Fed to cut interest rates, and the market has fully priced in two rate cuts this year!

The latest overnight data shows that US inflation in June "unexpectedly cooled", with both month-on-month CPI and core CPI falling short of market expectations:

Month-on-month CPI decreased by 0.1%, marking the first negative turn since May 2020, mainly due to a drop in gasoline prices.

Core CPI, excluding food and energy, only rose by 0.1% month-on-month, the smallest increase since August 2021, mainly impacted by the slowdown in housing cost growth.

The major highlight of this inflation report is the rapid cooling of the "stubborn" housing inflation, dropping from 0.40% to 0.17% month-on-month. Housing inflation has long been at high levels, serving as a major obstacle to rate cuts.

This provides the Fed with the confidence needed for rate cuts, with the market widely expecting the Fed to start cutting rates in September. Following the release of the CPI report on Thursday, traders are almost entirely betting on the Fed cutting rates twice in September and December.

Joseph Brusuelas, Chief Economist at RSM US LLP, stated in a report:

We are confident that even though the Fed is not yet ready to admit it, the inflation rate is returning to the 2% target, paving the way for a smooth rate cut by the Fed in September.

Noticeable Cooling of "Stubborn" Housing Inflation

Looking at specific items, housing prices are the largest category within the service sector, with a rise of about 0.2% month-on-month, the smallest increase since August 2021. Owner's equivalent rent rose by 0.3% month-on-month, also hitting a three-year low.

Julia Coronado, Founder of MacroPolicy Perspectives LLC and former Fed economist, commented:

The most important aspect of the June report may be the decline in housing inflation. Many Fed officials have indicated that it appears broad-based and persistent, and this decline will enhance their confidence that the inflation rate will indeed rise sustainably to 2%.

Apart from housing costs, other service prices such as airfare, hotel accommodation, and medical expenses also saw month-on-month declines. Core goods prices fell across the board, with new and used car prices leading the decline in core goods prices.For most of the past year, commodity prices have continued to decline, largely alleviating consumer concerns. In June, the "core commodity prices" excluding food and energy commodities fell for the fourth consecutive month. New car prices have been falling for the sixth consecutive month, prices of various clothing categories have also declined, and prices of household goods have decreased almost every month over the past year.

Rate cut in September is almost certain, could even happen in July?

Following the cooling of the U.S. non-farm data in June and Powell's mention of a rate cut, the unexpectedly low CPI in June further boosted expectations of a rate cut.

Several economists have indicated that the inflation data shows that U.S. inflation is steadily falling towards the 2% target level. The significant slowdown in housing inflation is particularly encouraging, which will enhance the Fed's confidence in the continuous decline of inflation.

After the June CPI report was released, U.S. Treasury bonds rose, with the market almost fully digesting expectations of rate cuts in September and December, while also increasing the likelihood of a rate cut in November to over 50%.

Bloomberg economist Anna Wong stated:

The CPI report for June is a step up from the "very good" report in May, which should boost the FOMC's confidence in the inflation trajectory, laying the foundation for a rate cut in September by the Fed, and even hinting at the possibility of an early rate cut in July.

Huatai Securities believes:

It is almost certain that the Fed will cut rates in September. With nominal growth rapidly declining, it would be more logical to cut rates in July, but the timing is somewhat rushed.

The Fed is likely to communicate its intention to cut rates in September at the Jackson Hole Symposium in late August, but it is not ruled out that the Fed may hint at it during the FOMC meeting on July 31.

Overall, the June inflation data has paved the way for the Fed to start cutting rates in September. Fed officials may release more policy signals at the end of July meeting, and the market will closely watch Powell's speech at the Washington Economic Club next Monday for more policy guidance