Tariff-Induced Inflation Drives June CPI to 2.7%

Recent economic data from the United States has revealed that tariff policies are beginning to manifest in price levels, marking the first official indication of tariff-induced inflation. While the bond market has shown a mild reaction, analysts caution that sustained inflation could rapidly alter market trends and policy directions.

The June Consumer Price Index (CPI) report, released on Tuesday, showed that tariffs are driving up the prices of certain goods. The overall CPI year-on-year growth rate increased from 2.4% in May to 2.7% in June, briefly causing a sell-off in the bond market. However, the market stabilized after the June Producer Price Index (PPI) report showed zero growth on Wednesday.

Analysts suggest that the Federal Reserve is likely to view this inflation as temporary. Economists had already anticipated that tariffs would exert some price pressure, with the key question being: "How long will the inflation last, and how high will it go?"

For the bond market, the extent and duration of tariff-induced inflation are crucial factors in determining this year's interest rate trajectory. This is also the focal point of the policy disagreement between the President and the Federal Reserve Chairman.

The President has repeatedly urged the Chairman to implement significant rate cuts to reduce the government's debt interest burden. However, the Chairman insists that it would be premature to cut rates without a comprehensive assessment of the impact of tariffs on inflation.

Currently, the effective date for several tariffs has been postponed to August 1, with market expectations that further delays are possible. Analysts note that while risk asset markets cheer each tariff delay, it extends uncertainty for the Federal Reserve.

In June, consumer goods prices, particularly those with a high proportion of imported components, saw accelerated increases. Excluding automobiles, core consumer goods prices rose 0.6% month-on-month, the largest monthly increase since 2022. Home goods prices increased by 1%, with home textiles like curtains and carpets rising by 4.2%, and appliances by 1.9%. Clothing prices rose by 0.4%, with men's shirts and sweaters increasing by over 4% in a single month. Excluding energy, service prices rose by 0.3%, although some categories like airfares saw declines.

Pacific Investment Management Company (PIMCO) suggests that the Federal Reserve may view these CPI data points as supportive of its cautious stance. "The rebound in goods inflation reflects tariff pressures, while deflation in the services sector persists, leaving room for rate cuts in September and beyond," the report states.

On the wholesale inflation front, June PPI showed zero month-on-month growth, with May's data revised to a 0.3% increase. Although overall stability is maintained, prices of some tariff-related goods show upward trends.

Economists at a major U.S. bank predict that the June Personal Consumption Expenditures (PCE) price index, the Federal Reserve's preferred inflation measure, will reach 2.8% and potentially rise to 3% in July. This could diminish the likelihood of a rate cut in September. "If the PCE index truly reaches 3%, we believe the probability of a September rate cut will significantly decrease," they stated.

PIMCO's senior investment manager suggests that the bond market currently views tariff-induced inflation as a temporary adjustment, to be digested over several months, with inflation expected to return to the Federal Reserve's target range afterward. Many companies have stockpiled inventory ahead of the tariffs' implementation, and the market is observing whether this inventory will continue to drive up prices once depleted.

"We expect prices to continue rising, but the magnitude may not be as high as initially anticipated," the manager said, noting that some tariff costs may have been absorbed by suppliers and companies, not fully passed on to consumers.

"The bond market is signaling that inflation will rise this year but will not spiral out of control," the manager added. Inflation is expected to be a one-time shock, not a recurring phenomenon over the next few years, as evidenced by the trends in inflation-protected securities and other inflation swap markets.

Despite market volatility due to tariff-related news, the manager pointed out that the U.S. Treasury market has remained stable over the past two to three months. "The 10-year Treasury yield has fluctuated within a narrow range of 15 basis points."

The manager also noted that the current 10-year Treasury yield of approximately 4.45% is attractive. "You can choose to hold and earn interest income. If the economy slows and the Federal Reserve cuts rates, bondholders could see double-digit returns."

Currently, Treasury yields remain near critical levels, with the 10-year yield approaching 4.5% and the 30-year yield near 5%. Analysts suggest that the market has shown resilience, with yields holding steady despite the June inflation data.