All-items inflation fell 0.4% for the month; annual rates also dipped.
By David Enna, Tipswatch.com
U.S. inflation fell in June at a rate much deeper than expected, a big surprise. But current events in Iran make this dip look “transitory,” an over-used word that seems appropriate today.
In June, the Consumer Price Index decreased 0.4% on a seasonally adjusted basis after rising 0.5% in May, the Bureau of Labor Statistics reported this morning. This was the largest 1-month drop since April 2020. Annual all-items inflation fell to 3.5%, well down from the 4.2% reported for May.
Core inflation, which removes food and energy, was flat for the month and the annual rate fell from 2.9% in May to 2.6% in July.
All these results were well below economist expectations, so the June report should be viewed as highly positive. But events of the last week — with the Strait of Hormuz again closed and U.S. launching nightly attacks on Iran — make the situation highly volatile.
A key factor in the June report, of course, was a 9.7% drop in gasoline prices, which remain up 26.7% year-over-year. The energy index was the largest contributor to the monthly all items decrease, the BLS said. This deflationary trend is highly likely to reverse in July and August. More from the report:
- Food at home costs rose 0.2% in June and are up 2.7% for the year.
- The meats, poultry, fish, and eggs index increased 0.6% over the month.
- The cost of eggs increased 4.3%.
- Costs for fruits and vegetables fell 0.2%.
- Shelter costs increased just 0.1%, but are up 3.3% for the year.
- Apparel costs fell 0.6% but are up 3.9% for the year.
- Costs of new vehicles were flat and are up only 0.5% for the year.
- Prices for used vehicles fell 0.2% and are down 1.8% for the year.
- The motor vehicle insurance index declined 2.0% in June after falling 1.7% in May.
- Airline fares rose 0.2% but were up 26.5% for the year.
Most of this looks routine, except for the deep decline in gas and energy prices. That may end up being a one-month story. However, the slowing of shelter inflation and drop in annual core inflation have to be viewed as positives. Here is the trend in all-items and core inflation over the last year:
What this means for TIPS and I Bonds
Investors in Treasury Inflation-Protected Securities and Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances for TIPS and set future interest rates for I Bonds. For June, the BLS set the inflation index at 333.952, a drop of 0.35% from the May number.
For TIPS. The June report means that principal balances for TIPS will fall by 0.35% in August, after rising 0.63% in June. Here are the new August Inflation Indexes for all TIPS.
For I Bonds. The June report is the third of a six-month string that will determine the I Bond’s new variable rate, to be reset November 1. So far, inflation has increased 1.13% over the three months, which translates to a variable rate of 2.26%. But three months remain. Expect lots of volatility. Here are the numbers so far:
What this means for future interest rates
If we could ignore the inflationary events of the last week, I’d say this June report would — at the least — allow the Federal Reserve to put future short-term rate increases on hold. But keep in mind that both all-items (3.5%) and core inflation (2.6%) remain too high for comfort.
If the situation in Iran continues to escalate, we will see higher gas prices, possibly steadily higher as the summer months continue. Higher gas prices obviously trigger higher immediate inflation, but also cause other consumer spending to decline. Fed actions on short-term interest rates will have little effect on that.
Today’s report led investors to sharply lower the chances that the Federal Reserve will raise rates at its July 28-29 meeting, the Wall Street Journal reported. Before the report, futures markets implied there was a close to 40% chance of a rate increase. That dropped to about 15% this morning.
I agree the Fed is again on hold until this situation clarifies (if it ever clarifies). Fed Chairman Kevin Warsh, in remarks prepared for Senate testimony this morning, had this to say:
“The members of our committee have no tolerance for persistently elevated inflation. And we share a resolute commitment to restoring price stability. … If we get policy right — and we will — the inflation surge of the last five years will be a thing of the past.”
That’s encouraging and would indicate the Fed will at least consider hiking rates if inflation continues rising. This is from Bloomberg’s morning report:
“The weaker inflation data likely keeps the Fed on hold for now and reduces any rate hike odds, but we remind investors that almost every communication that has emanated from Chair Warsh during his short tenure so far has been hawkish,” said Skyler Weinand at Regan Capital.
“Although a path remains for rates to stay unchanged this year, the re-escalation of the conflict has narrowed it,” he said.
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