June’s CPI Report Just Changed The Rate Debate: Here's What Investors Should Watch

June’s inflation report delivered a pleasant surprise, with the annual CPI rate falling to 3.5%.

The data was released just hours before new Federal Reserve Chair Kevin Warsh’s first congressional testimony, giving investors fresh insight into how the Fed’s policy outlook could evolve from here.

Here are the numbers:

• Headline CPI: 3.5% YoY, down from 4.2% in May, below the 3.8% forecast
• Month-over-month: -0.4%, the first monthly decline since the pandemic (forecast was -0.1%)
• Core CPI (MoM): 0.0% flat, missing the 0.2% forecast
• Core CPI (YoY): 2.6%, down from 2.9%

Strip out food and energy, and there was zero inflation last month. That’s the number that matters most for what happens next.

Why the CPI Report Changes the Fed Outlook 

One day before this report, Fed Governor Waller warned that a hot core print could force the FOMC to consider hiking. Well, the report came in flat instead, meaning that the hawkish case is now effectively off the table. 

The flat core print is the first genuinely clean signal in months that underlying price pressures are breaking, rather than just easing on the back of temporary swings in energy costs.

Furthermore, the premarket outperformance in small caps and growth names is a sign that money is rotating back into the sectors that had been priced for a more hawkish Fed just 24 hours earlier.

The inflation report strengthens the case for the Fed to keep rates unchanged or begin discussing rate cuts rather than additional hikes. For investors, that shift in expectation could have a meaningful impact on how markets are positioned in the months ahead.

What This Means for Investors 

As inflation continues to ease, the likelihood of the Federal Reserve cutting interest rates is increasing. If the rate cut happens, Treasury bonds could become more valuable because they lock in today’s higher yields before rates move lower. 

For investors, this could be a good time to consider intermediate- or long-term Treasuries rather than keeping excess cash on the sidelines, as cash returns are likely to decline once the Fed starts reducing rates.

Growth and small-cap stocks are often the biggest winners when investors expect lower interest rates. If you’ve been avoiding these parts of the market because of concerns that the Fed might keep raising rates, today’s inflation report may be a reason to take another look.

While today’s CPI report is encouraging, it’s still only one piece of the puzzle. The Federal Reserve will want to see inflation continue moving lower over the next few months before becoming confident that price pressures are truly under control. 

Rather than making major portfolio changes based on a single report, it’s best to wait for additional inflation data to confirm that the trend is real.

Conclusion

June’s CPI report is an encouraging step in the right direction. It suggests that inflation is cooling faster than many expected and reduces the immediate risk of another Federal Reserve rate hike. That’s a positive development for both the economy and financial markets.

For this projection to hold, the Fed will want to see similar progress in the months ahead before becoming confident that inflation is sustainably moving back toward its target. 

Right now, the best approach is to stay patient and disciplined instead of chasing the market’s initial reaction. 

Benzinga Disclaimer: This article is from an unpaid external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.