June CPI Data: Will Tariffs Sway the Fed's Decision?

All eyes are on the release of the US Consumer Price Index (CPI) data for June at 8:30 PM EST today. The Federal Reserve is closely monitoring this data to assess the impact of tariffs on inflation and determine whether it can proceed with the anticipated rate cut in September. Market expectations indicate that the US June unadjusted CPI year-over-year is projected to be 2.7%, with a monthly rate of 0.3%. The seasonally adjusted core CPI year-over-year is expected to be 3%, with a monthly rate of 0.3%. These projected values are notably higher than previous readings.

The Impact of Tariffs on Inflation

Investors are eager for the Fed to resume rate cuts, but officials have expressed concerns that tariffs could push inflation higher, potentially delaying a shift in monetary policy. So far, the impact of Trump's tariffs on US inflation appears limited. In May, goods price inflation remained modest, but the "trade war" is far from over. Last week, Trump sent tariff warning letters to over 20 countries, in addition to imposing a 50% tariff on copper starting August 1. If implemented, the average effective tariff rate in the US would rise from the current 15% to around 18%, the highest level since 1934. This is certainly not a direction in which the Fed can afford to be complacent about inflation.

Lagged Effects of Tariffs

The transmission of tariffs to consumer prices may be delayed by several factors, including uncertainty about the duration and ultimate level of tariffs, inventory build-up, supply chain adjustments, long-term contracts, and competitive pressures arising from price-sensitive demand. The Fed is likely to remain in wait-and-see mode until it can better disentangle these factors and assess the extent to which the shock has been transmitted to prices.

Positive Indicators, But...

The minutes from the June FOMC meeting noted that the Fed staff's forecasts for GDP growth and inflation had improved compared to May, and recession risks had declined. This aligns with the stock market rebound and improved market inflation expectations during the same period. The results of the New York Fed's June consumer expectations survey also seem to confirm this trend, with one-year inflation expectations falling for the second consecutive month. However, regarding more specific commodity price expectations, consumer expectations for the prices of medical services, university education, rent, food, and gasoline continued to rise, mostly returning to levels from early in the pandemic and sharply increasing since the beginning of the year.

Significance of the June CPI Data

This is why the June CPI report is significant. Investors are currently taking an "optimistic" stance on tariff-related inflation risks, betting that inflation expectations will remain anchored, and that the Fed will overlook the rebound in goods inflation because service inflation is cooling. According to the CME FedWatch tool, federal fund futures currently imply a roughly 70% probability of a rate cut in September. However, the lag in tariff transmission and the ongoing trade war increase the risks that the Fed needs to wait longer to clarify the outlook for monetary policy. From March to May, a sharp drop in oil prices and moderate service inflation helped contain overall price pressures, but the June CPI data could be a crucial test of this favorable trend. Oil prices rose by 10%, while retail gasoline prices remained largely flat, meaning the "tailwind" of falling energy prices for the CPI has diminished. At the same time, there may be limited room for further cooling in the service sector, as many sub-sectors have stabilized. The performance of the June ISM manufacturing and services price indices is noteworthy, continuing to show elevated price pressures.

Divergent Expectations

But some market strategists say that while Wall Street expects June CPI inflation to rise due to tariffs, the stock market may see it as a one-time price increase, rather than a broader inflationary shift, which could prevent the Fed from cutting rates later this year. Thierry Wizman, global foreign exchange and interest rate strategist at Macquarie Group, pointed out that financial markets may be insensitive to this inflation data, "In the past few months, investors have become more relaxed about the overall inflation outlook... I wouldn't say the market has shifted to a deflationary mode, but it is certainly less inclined to worry about inflation." Wizman added that the performance of inflation sub-items is just as important as the overall and core CPI data. He added that tariffs are currently expected to primarily affect core goods prices, and if service inflation continues to show signs of easing, the market may largely "ignore" these price increases. Service inflation accounts for a significant share of the CPI report, representing about 57% of the data, while core goods inflation accounts for only 20%. Therefore, Wizman said that investors still need confirmation from the discretionary parts of the service basket (such as airline tickets, used cars, clothing, and furniture) to determine whether inflation is really fading. Conversely, if the June CPI report shows another surge in service inflation, and a widespread increase in demand-driven price pressures, investors will be "more worried that there is something unrelated to tariffs behind these numbers, which could give the Fed more reason to delay a rate cut." Markets will remain vigilant in monitoring incoming data to assess the future path of US monetary policy.