Key Information

On July 13th, the Labor Department reported the Consumer Price Index of June.

CPI soaring to 9.1% indicates a severe inflation. As we all knows, The Federal Reserve has raised interest rate three times in a roll recently. With such a tough tightening policy, why has inflation repeatedly hit previous highs? Was the Federal Reserve's monetary policy ineffective confronted with inflation?  

Another key point is that Core CPI slips to 5.9% from last month’s 6%, which is the third straight month of Core CPI decline.

What’s the difference between CPI and Core CPI?

The CPI (Consumer Price Index) is a statistic estimate of price changes constructed using the prices of products and services related to people's daily life, including energy, food, goods and services as sample representative items. The annual percentage change in a CPI is used as a measure of inflation. The Core Consumer Price Index measures the changes in the price of goods and services, excluding food and energy.

Let’s explain a concept here-Demand flexibility.

People are very insensitive to food and energy prices,

which simply means that they don't cut back too much even if those prices go up significantly.

Core CPI, on the other hand, refers to the high demand flexibility for goods and services. When prices rise, people will inevitably reduce their spending on purchases and other services. Therefore, Core CPI reflects the price situation more accurately.

However, such divergences between CPI and Core CPI

usually don’t last long, eventually they will converge.

The continuous downward trend of Core CPI also proves that the Federal Reserve's interest rate hike was effective on inflation.

Have we hit peak inflation?

Over the past three months, the CPI was mainly driven by food and energy. Since the start of the year, food and oil prices soared due to supply chain volatility, yet inflation caused by supply is not possible to be solved by raising interest rates only.

It’s reported that Russia and Ukraine will expect to reach an agreement on grain shipments next week, which may ease the global food crisis. The Food Price Index disclosed by the Food and Agriculture Organization of the United Nations has also turned downward in June and will be reflected in CPI food prices.

The recent decline in crude oil prices has also eased pressure on refined oil products, and gasoline prices have been heading lower for the past month, and are expected to fall even lower.

Moreover, U.S. consumers' expectations for growth in household spending over the next 12 months fell in June, according to a Federal Reserve survey released on July 11th, which also predicts a looming slowdown in demand.

To sum up, with demand weakened and supply eased, the Federal Reserve may see a “clear inflation decline”in the second half of the year. 

Rate hike & rate cut expectations soar together

Inflation of June has gone far beyond expectations of the market, which may lead to a more hawkish decision by the Federal Reserve with a 75-basic- interest rate increase in July.

Now market expectations of possible Fed Funds rate hike of a full percentage point climbed to 68%, which was close to 0% a day before.

However, with overnight expectations of a Fed rate hike this year rising rapidly, expectations of subsequent rate cuts have also surged.

Markets are now expecting cuts of up to 100 basis points over a year from February, with a quarter-point cut in the first quarter already fully priced in.

In other words, the Fed likely will raise interest rates more than expected in the second half of this year, but rate cuts will also come earlier next year.

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