Soft US CPI Eases Fed Hike Bets; BoC to Hold as Oil Risks Persist

A softer-than-expected US inflation report for June led investors to pull back on Federal Reserve rate-hike bets, though the repricing was limited. Renewed hostilities in the Middle East and cautious remarks from Fed Chairman Kevin Warsh kept the dollar bid and oil elevated.

June's headline CPI dropped 0.4% month-on-month, its first decline since early 2020. Year-over-year, headline inflation eased to 3.5% from 4.2% in May, while the core rate fell to 2.6% from 2.9%. The monthly decline was driven by lower gasoline and used-car prices. Core price momentum held steady at 0.2% from the prior month.

US Treasury yields bull-steepened after the release. The dollar fell initially. The move faded. For broader forex market analysis, visit forex market analysis. Overnight index swaps still price in 27 basis points of tightening by year-end. The implied probability for September is 16 bps and for October 22 bps.

Warsh, in his first congressional testimony since taking the helm, offered no hint that a rate hike is on the table this month. He said one month of softer data does not mean "mission accomplished," according to his prepared remarks.

In the Gulf, the US and Iran continued to exchange blows. President Trump has pushed forward a naval blockade of Iranian shipping and dropped the 20% fee for escorting vessels through the Strait of Hormuz. Brent crude traded near $85 a barrel, eyeing the 50-day moving average at $88.92.

Equities took their cue from the data and oil. The S&P 500 rose 0.4% and the Nasdaq gained 0.9%. The Dow was unchanged on the day. IBM plunged 25% on a weak earnings outlook, offsetting gains from Goldman Sachs and a rebound in semiconductor stocks. Bank earnings generally beat estimates, with JPMorgan, Bank of America, Wells Fargo, Citigroup and Goldman all exceeding expectations. JPMorgan shares rose 2.5% to $342.89 on the day. The stock carries an Alpha Score of 63 with a Moderate label, according to AlphaScala data.

Now the focus shifts to the Bank of Canada, which is widely expected to leave its overnight rate unchanged at 2.25% later today for the sixth consecutive hold. The OIS market has repriced from fully pricing in a rate hike by year-end to just 16 bps of tightening since the June meeting.

Governor Tiff Macklem has described policy as being in a "holding pattern," with the overnight rate at the lower end of the neutral range. The bank balances soft GDP growth against above-forecast inflation. The labor market is loosening and core inflation measures hover around 2%. Growth bounced back in the second quarter after flatlining in the first. The bank's Business Outlook Survey showed 44% of firms expect inflation above 3% over the next two years.

The decision itself is baked in. Attention will fall on the rate statement, the press conference and the updated Monetary Policy Report. Aaron Hill, chief market analyst at FP Markets, expects the bank to maintain a neutral stance, open to either a hike or a cut. He anticipates the all-items inflation component will be revised higher in the MPR after headline CPI reached 3.2% in May. He does not expect much change in core inflation updates.

For the Canadian dollar, the trade is binary. If Macklem downplays the recent growth rebound and emphasizes the loosening labor market, traders may further pare rate-hike expectations, pushing short-term yield spreads lower and underpinning USD/CAD. If he focuses on the 3.2% headline and the unanchored corporate expectations, traders could add to rate-hike bets, pushing yield spreads higher and weighing on USD/CAD.

Hill said the only trade for the loonie is if Macklem shifts from his neutral stance, which he does not expect to happen at this juncture. The Bank of Canada decision is due later today.