A week of two narratives: Cooling inflation vs. escalating conflict

Last week brought two of the most important data points of the month: June Consumer Price Index (CPI) on Tuesday and June Producer Price Index (PPI) on Wednesday. Both came in softer than expected, both triggered a sharp repricing of Fed expectations, and both were quickly complicated by events that unfolded within 48 hours. 

Headline CPI fell 0.4% on the month, the biggest monthly drop since April 2020, pulling the annual rate down to 3.5% from May's 4.2% and well below the 3.8% consensus. Core CPI held flat on the month, with the year-on-year rate steady at 2.6%. The relief was almost entirely an energy story, prices fell 5.7% for the month as the US-Iran ceasefire reopened the Strait of Hormuz and unwound the oil spike that had driven May's hot reading.

The market reaction was quick. Going into the CPI release, odds of a hike at the July 28-29 FOMC meeting had been running as high as 43%, reflecting a hawkish-leaning and reportedly split committee after May's hot print. Within a day of the CPI and PPI releases, hike odds for July collapsed to around 10-13%, with a hold now priced at roughly 90%. September pricing moved in the same direction initially, but it didn't stay settled, strong retail sales and a drop in jobless claims later in the week, combined with fresh Middle East escalation pushing oil back up, nudged September hike odds back toward the 50% area. Fed Chair Kevin Warsh added his own hawkish counterweight in Congressional testimony the same week, calling recent inflation readings an imperfect measure of the underlying trend and saying he isn't satisfied with where inflation currently sits. So the net effect is that a July hike is essentially off the table, but the September decision, and the Fed's actual tone at the July meeting, remain genuinely open questions. 

The dollar and gold reacted almost exactly as you'd expect in the hours after each release, then partly reversed as the week went on. The DXY fell on the CPI print and extended its slide after PPI, dropping about half a percent toward the 100.40 area. That move unwound by Thursday as solid retail sales and a 10-week low in jobless claims pushed the dollar index back up near 100.54, with the 10-year yield holding around 4.56-4.57%.

Gold spiked on the CPI beat, briefly touching near $4,088 an ounce as hike odds collapsed, but the rally didn't hold. By Thursday gold had drifted back toward $4,000, as renewed US strikes on Iranian targets and Tehran's retaliation pushed oil to a one-month high and revived worries that energy costs, and therefore inflation, could reaccelerate.

That's the clearest takeaway from the week: both moves were textbook-correct in the short window right after the data, but both were substantially unwound once oil-driven geopolitical risk reasserted itself. Right now, inflation data is essentially hostage to the energy complex, and the energy complex is hostage to the Middle East.

With a hold now the base case for July 29, the meeting itself is less about whether the Fed moves and more about tone, and there are a few things worth watching closely between now and then. Oil and the Iran situation matter most, since any further escalation would mechanically push energy prices, and headline inflation, back up and undercut the disinflation story currently supporting rate-cut hopes. Warsh's further public comments are worth tracking too, since his testimony already signaled discomfort with declaring victory, and any hardening of that language would matter for how markets read the meeting.