Despite a relatively busy week on the economic data calendar, market attention remained focused on renewed tensions in the Middle East. Earlier in the week, Iranian forces attacked multiple oil vessels transiting the Strait of Hormuz, prompting the U.S. to resume strikes on various military targets across Iran and reimpose its naval blockade. Tanker traffic through the vital passageway has again come to a halt, pushing WTI prices back above $80 per barrel. 

The renewed upward pressure on oil prices helped to temper the market response to an otherwise very encouraging inflation report. Headline CPI declined by 0.4% m/m in June – it’s first pullback since June 2024 and largest since April 2020 – pushing the 12-month change down to 3.5% (see commentary). A sharp drop in gasoline prices was largely responsible for last month’s decline, though even after removing these effects there were plenty of positive developments. Core inflation was flat for the month, as both goods and services were little changed (Chart 1). Importantly, many of the categories where tariffs had been adding to price pressures over the past year, including appliances, medical goods and apparel were all lower on the month – suggesting the worst of the tariff passthrough is now in the rearview mirror. Also encouraging was the fact that there was little evidence of higher energy prices bleeding into core inflation. 

The disinflationary dynamics were further reinforced by a soft producer price index reading, which helped to remove speculation of a Fed rate hike later this month. That said, Fed futures are still priced for a little more than one rate hike by year-end, as the U-turn in oil prices is already raising concerns on the durability of the disinflationary dynamics. 

Retail sales for the month of June provided further confirmation that households continue to shrug off the effects of higher energy prices (Chart 2). While the headline figure posted only a modest gain, that was partly related to a sharp drop in nominal sales at gasoline stations –owing to price effects (see commentary). Focusing on the control group, which removes volatile categories, it showed a much healthier gain in spending while revisions to the prior month were a bit higher. This reinforces the view that consumer spending regained some momentum in Q2, after sputtering in Q1. However, the spend dynamics remain K-shaped, with lower-and-middle income consumers increasingly price sensitive and hesitant to spend on discretionary items – something that was highlighted in this week’s Fed Beige Book. 

Anyone hoping that Fed Chair Warsh would relent and provide some forward guidance during his first Congressional testimony this week was sorrily disappointed. Instead, Warsh restated the Committee’s unwavering commitment to return price stability, but provided no hints on the Fed’s next move. Several other policymakers spoke this week and perhaps the biggest takeaway is that while all were encouraged by last month’s softer inflation figures, one data point does not make a trend. Several more months of easing inflation will be required to convince officials that price pressures are moving in the right direction. If this were to occur, expectations for rate hikes should fade, leading to some downward pressure on yields.