PPI and CPI together dampen expectations for a rate hike in July! US June PPI drops for the first time in nearly a year, and Middle East conflicts remain the biggest variable in inflation.

A key producer inflation indicator (PPI) in the United States, known as the "upstream economic barometer," unexpectedly fell below economists' expectations, further indicating that the inflationary effects of the rise in energy prices caused by the Iran war and the high oil prices are still largely under control. It also indicates that the pressure from market expansion and early-stage production pipeline construction has been significantly eased before the recent outbreak of the Iran war. Following Tuesday's unexpectedly weak CPI data, the PPI data once again confirmed the continued cooling trajectory of inflation dominated by the fall in energy prices, prompting traders to significantly reduce their expectations of a rate hike by the Federal Reserve in July. The mainstream expectation of a rate hike in the interest rate futures market has retreated from July to December. Data released on Wednesday by the U.S. Bureau of Labor Statistics showed that the core producer price index in June, excluding food and energy, rose by 4.7% over the same period last year, significantly below economists' consensus expectations. The overall producer price inflation (the so-called "PPI indicator"), which includes food and energy, showed a significant slowdown, mainly due to a sharp 12% drop in gasoline prices. As shown in the above figure, U.S. producer price inflation was unexpectedly moderate- the key indicator rose by only 4.7% year-on-year in June, significantly below expectations. The June PPI index unexpectedly fell by 0.3% from the previous month, recording the first decline since August of last year, significantly lower than economists' expectations of a monthly increase of about 0%; the year-on-year PPI increase narrowed significantly to 5.5%, well below economists' consensus expectations of around 6.2%. The core PPI, excluding food and energy, rose 4.7% year-on-year, lower than economists' consensus expectations of about 5.1%, with a monthly increase of 0.2%, lower than economists' consensus expectations of 0.3%, and the previous value was about 0.4%. The PPI index, known as the "barometer of upstream price pressures," measures the selling prices received by domestic producers and can reflect changes in raw material, energy, transportation, and intermediate product costs relatively early. Therefore, it has a certain leading and predictive significance for future CPI and PCE inflation. However, factors such as corporate profit margins, productivity, import prices, and cost pass-through capabilities may weaken transmission, so it is not sufficient to judge future inflation based solely on the PPI, but a comprehensive analysis combining CPI, core PCE, wages, and inflation expectations is still needed. The June CPI and PPI jointly indicate a marginal cooling of inflation and a reduced urgency for rate hikes in the near term. The latest remarks from the third-ranking official at the Federal Reserve, New York Fed President Williams, indicate that he recognizes that current inflation is still around 4%, which is "undoubtedly too high," but believes that the impact of tariff prices, housing inflation, energy costs, and supply and demand gaps caused by AI investments may gradually ease, with overall inflation expected to drop to around 3.25% by the end of the year and return to 2% in 2028. The latest forecast from the Wall Street financial giant Citigroup shows that the institution predicts that as inflation continues to cool, the Fed will not shift to a rate hike stance, and is betting that the Fed will cut rates by 25 basis points in October and December 2026, with the third rate cut occurring in January 2027; it had previously forecast consecutive rate cuts in September, October, and December 2026. U.S. PPI unexpectedly moderate, betting on a rate hike by the Fed in July disappearing The PPI data report shows that several key categories that have risen in recent months due to war-related factors have generally cooled. This may provide the Federal Reserve with greater leeway to postpone rate hikes, especially after another report on Tuesday showed that U.S. consumer prices were also moderate in June. However, many economists believe that this easing of energy and core inflation may be temporary as geopolitical tensions in the Middle East have escalated again in recent weeks. After the report was released, U.S. stock index futures rose, U.S. Treasury bond yields fell, and investors significantly reduced their bets on a rate hike by the Federal Reserve in July. The current pricing in the interest rate futures and swaps markets shows that the probability of a rate hike in July has fallen to about 5%, with the probability of a rate hike in September around 40%. Federal Reserve Chairman Kevin Walsh warned on Tuesday in a congressional testimony that the fight against inflation is not over just because the consumer price report is favorable. Data released on Wednesday shows that energy prices fell by 6.4% in June from the previous month, and prices for transportation and warehousing also fell slightly. Despite this, truck freight rates remain high due to rising fuel costs and a reduction in the number of drivers resulting from President Donald Trump's tightening of immigration policies. At the same time, food prices fell for the first time in three months. Overall, food prices have been rising this year due to various factors such as adverse weather, war, and tariffs. Several sub-items in the Producer Price Index are closely monitored by the Federal Reserve because they will be included in its preferred inflation measure - the Personal Consumption Expenditure Price Index. The performance of these sub-items varies: airfare prices rose by 1.9%, but the increase in portfolio management fees was much lower than in May. The U.S. Bureau of Economic Analysis is scheduled to release personal consumption expenditure price data for June on July 30, as well as income and spending data. "With the current data in hand, we estimate that the personal consumption expenditure price inflation index (PCE), which is the Fed's most favored inflation gauge, will be slightly stronger than the moderate performance of the consumer price index in June, but it may still be moderate enough to keep the Fed interest rates unchanged at the next few meetings and even until the end of the year," said Troy Dury, senior economist at Bloomberg Economics. An indicator of inflation pressures in the early stages of production processes, excluding food and energy, the price of intermediate demand processed goods only rose by 0.6%, the smallest increase since the beginning of the year. Prices for plastics and materials, key raw materials for many consumer goods, fell for the first time in 2026. The report also shows that two other emerging sources of inflation pressure this year - data centers and defense production - have both cooled. Prices for electronic components and parts fell for the second consecutive month, and prices related to government defense procurement fell by 2.2%. Details on wholesale and retail trade service profit margins in the Producer Price Index report have also been closely watched to assess the extent to which companies are absorbing tariff-related costs on their own or passing them on to consumers. Profit margins in June rebounded somewhat after a significant decline in May. While the U.S. Supreme Court overturned several tariffs implemented by Trump earlier this year, the government is seeking other ways to levy taxes on imported goods. The United States has also decided not to renew its long-term trade agreement with Canada and Mexico, opting for annual reviews instead, which could bring more uncertainty to businesses in the coming months. Another report released on Wednesday by the Federal Reserve Bank of New York showed that with new orders and shipments increasing, and employment indicators reaching their highest level since December 2022, the overall manufacturing business conditions index for July rebounded slightly. The pricing index has dropped slightly, but remains at a high level; businesses have lowered their expectations for future price and sales prices. Williams releases a dovish buffer, Walsh stands firm on a hawkish bottom line, Citigroup bets on the "three rate cuts" playbook The joint message conveyed by the June CPI and PPI signals a marginal cooling of inflation and a reduced urgency for rate hikes in the near term: the overall CPI fell by 0.4% month-on-month, down from 4.2% to 3.5% year-on-year, while the core CPI remained unchanged month-on-month and fell to 2.6% year-on-year; the final demand PPI in June fell by 0.3% month-over-month and rose by 5.5% year-on-year, while the core index excluding food, energy, and trade services only rose by 0.1% month-on-month. The two reports indicate that the cooling of energy prices, the slowdown of housing inflation, and the tempering of some production costs are temporarily restraining the inflation slope, but the year-on-year level of the PPI is still high, and sub-items related to the Personal Consumption Expenditure Price Index, such as airfares and asset management fees, remain resilient. Therefore, it is more appropriate to define this as a hawkish risk downgrade rather than a complete victory for inflation. Federal Reserve Chairman Walsh's hearing essentially established a hawkish policy response function but did not provide a direction for the next move: he emphasized a "zero tolerance" for sustained high inflation and refused to announce the "task completed" in response to a mild CPI, while deliberately refraining from committing to a rate hike in July or subsequent meetings, reiterating that interest rates and the balance sheet are both available tools. His real new policy signal is the weakening of traditional forward guidance, the strengthening of incremental meeting and all-data decision-making, and a reassessment of the ample reserve framework, asset holding structure, and Fed communication mechanisms; this helps to preserve policy flexibility but may increase the marginal impact of each inflation, employment, and oil price data on the market. Williams' remarks fall into the conditional neutral dovish category: he acknowledges that current inflation is still around 4%, which he describes as "undoubtedly too high," but he believes that the impact of tariff price shocks, housing inflation, energy costs, and supply and demand gaps caused by AI investments may gradually ease, and he expects overall inflation to drop to around 3.25% by the end of the year, returning to 2% in 2028; at the same time, Williams believes that the U.S. non-farm labor market has not created additional inflation pressure, and the unemployment rate is expected to slowly decline to 4%. However, New York Fed President Williams, who has permanent voting rights on the Fed's FOMC during his term, did not advocate an immediate rate cut, and the FOMC members are roughly divided between "no rate hikes this year" and "at least one more 25 basis point rate hike." Therefore, there is no fundamental conflict between Walsh and Williams: the former emphasizes vigilance before seeing continuous evidence, while the latter believes that the current 3.50%-3.75% interest rate level is sufficient to wait for inflation to naturally decline. Both of them to some extent point to a pause in July and maintain a two-way choice in subsequent meetings; it's just that Walsh's stance is clearly more hawkish. In the view of most economists, the substantial decline in U.S. inflation this time is largely due to the fall in energy prices in June - CPI energy sub-items fell by 5.7%, PPI energy prices fell by 6.4%; however, as tensions in the Middle East have escalated again, oil prices have risen again. At the same time, economists widely predict that the core personal consumption expenditure price index (or core PCE) for June might still reach around 3.3%, significantly higher than the Fed's 2% target; although New York Fed President Williams believes that inflation may have already peaked, he still describes the current inflation as "undoubtedly too high". Therefore, in the eyes of most economists, it is close to a consensus that the Fed will stay on hold in July, and the probability of staying on hold for the whole year has significantly increased, but there still remains a tail risk of rate hikes after September this year. If core inflation remains moderate for several more months, and if jobs and consumption show significant cooling, while the Middle East situation eases and drives down energy prices, then Citigroup's dovish path may indeed become the market's main theme again. The Citigroup economics team predicts that the Fed's FOMC will cut rates by 25 basis points in both October and December 2026, with the third rate cut occurring in January 2027; but Citigroup also admits that one instance of CPI and PPI falling below expectations is not enough to prove that the Fed will implement multiple rate cuts quickly in an economy that still shows resilience.