Fed leaves rate outlook steady as inflation report comes in cool

Economic outlook

Last week, markets had a busy week with two of the most highly anticipated events — the CPI release and the June Fed meeting. CPI data surprised to the downside, with headline inflation flat month-over-month and core inflation ticking up a mere 0.16% compared to market expectations of 0.10% and 0.30%, respectively. Encouraging signs included the broad-based drop in inflation, with core services posting a sharp drop and core goods remaining deflationary. Sticky inflation — a measure of items that change price less frequently — also ticked down during May. The only caveat to the good news was shelter inflation remained elevated, a lagging effect that continues to make up more than half of inflation. The 10-year Treasury dropped significantly from 4.40% to 4.25%, following the unambiguous good news.

While the report showed a very positive move towards the Fed’s inflation target, Fed officials refrained from reacting too strongly to one data point. Federal Reserve Chair Jerome Powell confirmed that Federal Open Market Committee (FOMC) participants had the opportunity to update their forecasts based on the data but hinted that many left their estimates unchanged. Division could be emerging within the FOMC, as eight members expect to cut rates twice before the end of the year, while seven of their counterparts assert one rate cut as the most likely scenario. The remaining four members predict no change at all, bringing the median to one rate cut by the end of the year. That reflects a significant drawback from the beginning of the year, when officials expected to cut rates three times before the resurgence of inflation forced those expectations to recede. The Fed’s reticent reaction to the CPI print caused rates to tick back up slightly. However, overall, the market is meaningfully more dovish than the Fed, with at least two rate cuts currently priced in through the end of the year.

FX market

The U.S. Dollar Index continued its rally this week, aided largely by unchanged interest rates. Most of this strength has been concentrated in the weakening of the Japanese yen and euro. The relatively hawkish stance of the Federal Reserve contrasted with the European Central Bank (ECB), which is widely expected to continue lowering rates. The euro also weakened against the dollar after the recent European Parliament elections. The yen continued its slump against the dollar following the Bank of Japan (BoJ) meeting this week. The BoJ moved cautiously, keeping rates at 0%. The meeting also included few details of a planned decrease in bond buying over the next few years, opting instead to delay the full release of the plan. This continued the weakening of the yen against the dollar, signaling that markets are impatiently waiting for the BoJ to provide more concrete details on its plans.

Commodities

After global energy agencies announced projections for oil demand in 2024 showing relatively strong growth, Brent futures climbed this week to their highest in over four months. Both the Organization of the Petroleum Exporting Countries (OPEC) and the U.S. Energy Information Administration (EIA) improved their projections for oil demand slightly, with both predicting significant supply deficits for much of the year. Though this sent futures higher (4.50% over the course of the week), the recent announcement of unchanged interest rates by the Fed served to counteract this rally in the short-term. However, with oil prices down 2.00% in the recent CPI and the Fed signaling optimism for rate cuts in December, oil futures recovered to end the week on a high note.

Looking ahead

Next week, May retail sales data will provide key information about U.S. consumer spending. This is coupled with multiple speeches by regional Federal Reserve Presidents that are expected to trickle in throughout the week. The Bank of England (BoE) will meet on June 20, with all signs pointing to rates remaining steady ahead of the July 4 general election.