June CPI Marks Progress Along the Last Mile to Inflation Target

Federal Reserve policymakers closely watch core inflation data for signs of cooling, and June offered a second straight month of surprisingly low readings in the core Consumer Price Index (CPI). It rose just 0.06% in June, the softest pace since January 2021, meaning core inflation is now running at 3.3% year-over-year (according to the U.S. Bureau of Labor Statistics). A key detail was the step down in shelter inflation, which has been a major driver of above-target inflation thus far.

The shelter data, along with recent employment data – in particular the return to pre-pandemic levels in the ratio of job vacancies to unemployed workers – could give Fed officials greater confidence, and potentially tee them up in September to begin what will likely be a series of rate cuts.

Looking at the overall CPI data and trends, we don’t believe June’s 0.06% core pace is likely to be the new average monthly pace going forward. Shelter inflation appears to have stepped down to a slower pace, but more volatile categories such as travel services and car prices are unlikely to continue to drop this much, and shipping costs could lead to higher goods prices.

Taking a step back, since 2022, we’ve argued that the last mile of the U.S. inflation journey back to 2% (the Fed’s target) was going to be the slowest. However, a cooler labor market, as well as a slowdown in immigration that eases some of the inflationary pressure in housing markets, should help narrow – or even eventually close – the gap between the current inflation rate and the target. We believe June’s inflation report was an important step along this last mile.

June CPI details: Shelter inflation eases

The big news was that shelter inflation finally slowed in June. Monthly price changes in rents (+0.3% in June versus +0.4% in May) and owners’ equivalent rents or OER (+0.3% versus +0.4%) both moderated meaningfully.

Prior to the June report, rental inflation had been surprisingly firm this year, even after accounting for the expected catch-up in price levels following the pandemic, and differences between single and multifamily housing rental markets. Elevated immigration in the second half of 2023 followed by a marked slowdown in 2024 may explain the corresponding swings in shelter inflation data, most notably in cities where new immigrants now reside. There is some noise in the shelter data – rents in the New York area jumped in May and then were somewhat softer than expected in June – but overall, we believe the slowdown in immigration is an important signal for continued shelter disinflation. (For details, please read our 25 June 2024 Macro Signposts.)

Other services categories were also relatively soft in June, which should add to the Fed’s confidence that a cooler labor market is reducing service inflation pressures. Core services ex shelter – another important gauge for Fed officials – was in deflation (−0.05% in June) for a second straight month, partly driven by another weak month for travel service prices (such as hotels and airfare) as well as softness in other service categories including education, recreation, and medical services. Motor vehicle insurance was one exception, rising 0.92% in June after prices unexpectedly fell in May.

Core goods prices continued to fall, led by used car prices, which are now down 9.5% over the past year. New vehicle prices also fell in June, though deflation remains moderate in this category. Other core goods prices were generally firmer.

Headline CPI inflation fell 0.1% in June thanks to weak energy prices. Food prices were somewhat firmer, and overall food inflation appears to be reaccelerating modestly after minimal changes for the last few months.

Moderating inflation and growth could contribute to yield curve steepening

The June inflation data reinforced our view that macro factors could foster a steeper U.S. Treasury yield curve. The curve has been inverted for years, albeit less dramatically of late, but two developments could help the curve normalize from here: First, moderating inflation and growth momentum (we expect real GDP to slow in the second half of the year) could lead to a sequence of Fed rate cuts. Second, the market for U.S. Treasury securities could potentially price additional risk premium associated with the growing chances of a second Trump administration – whose policies have potential to be stagflationary and further expand the deficit. (Learn more in our 10 July 2024 Macro Signposts.)