A Tougher Fed and a Turning Inflation Cycle

• Annualized CPI growth touched 4.2% in May.

• Annualized wage growth slowed to 3.5%.

• Falling gas prices may already be turning the tide.

The Federal Reserve turned more hawkish last week, but falling gas prices may have already undone the pivot…

Last week brought another important update from the Fed. During new Chairman Kevin Warsh’s first meeting in charge, our central bank left the federal funds target unchanged in a range of 3.50% to 3.75%. This marked the fourth straight meeting that monetary policy remained on hold.

However, there was a noticeable shift in the Federal Open Market Committee’s tone. Coming into the decision, policymakers like Cleveland President Beth Hammack, Dallas President Lorie Logan, and Philadelphia President expressed concern about rising oil prices. They’re worried that the longer costs remain elevated, the worse the inflation outlook could become. As a result, the Fed raised its interest rate expectation for this year from a cut to a hike.

Yet, based on recent gas price data, that outlook may already be starting to change. According to the U.S. Energy Information Administration (“EIA”), gas prices so far through June are already down 8% compared to May. That should place downward pressure on headline inflation growth. That should ease pressure on the Fed to raise rates, underpinning a steady rally in the S&P 500 Index.

But don’t take my word for it, let’s look at what the data’s telling us…

When considering interest rates, policymakers pay close attention to inflation expectations. The New York Fed publishes a survey on this measure each month. If Fed officials see the gauge steadily rising, it’s a signal households believe that prices will keep going up. As a result, they may start stockpiling goods, pushing prices even higher. And lately, expectations for the price outlook have remained in check.

But policymakers did receive a subtle warning earlier this month. Atlanta Fed wage data shows inflation running ahead of wage growth…

The above graph shows the Atlanta Fed’s three-month moving average of annualized hourly wage growth. I then compared it to the annualized pace of the consumer price index (“CPI”) growth from the U.S. Bureau of Labor Statistics. As you can see, most of the time, wage gains tend to outpace inflation. That’s important because it means individuals can earn money faster than the costs of goods increase. As a result, they should be able to pay for whatever they need and still have savings left over.

In May, CPI rose 4.2% while wages grew 3.5%. Most of the time, wages outpace inflation, giving households breathing room. When that flips, consumers feel squeezed. Historically, that dynamic has preceded periods of hoarding behavior and, eventually, Fed tightening.

That’s why this signal matters. If it persists, the Fed will worry that households may shift into “buy now before it gets worse” mode.

But there’s relief building on the other side of the ledger.

The U.S. and Iran appear to be inching toward a fragile easing of tensions in the Middle East. It won’t be smooth, but early signs suggest more oil is flowing out of the Persian Gulf. That’s already weighing on crude and gasoline…

The latest EIA data shows the average gallon of gas in June at $4.24, down from $4.61 in May. That’s an 8% decline after last month’s 9% jump. Because the recent inflation flare‑up was driven largely by energy, the reversal should have an equal and opposite effect.

For the Fed, this is the pivot point. If gas prices continue to fall, inflation should cool with them. That would push inflation back below wage growth, reduce pressure to hike, and reopen the door to cuts.

At the end of the day, the Fed’s hawkish turn is likely to prove short‑lived. The setup should support a steady rally in the S&P 500.

Five Stories Moving the Market:

President Donald Trump warned the U.S. could strike Iran over its support for Hezbollah, as fighting between the militant group and Israel threatened to upend the preliminary peace deal he signed last week and close the strategic Strait of Hormuz – WSJ. (Why you should care – Vice President JD Vance was optimistic about progress made during talks in Switzerland)

Millions of barrels of oil continued to flow through the Strait of Hormuz this weekend even after Iran claimed to have closed the waterway again, as the U.S. and Iran offer contrasting narratives over the status of the world’s most important shipping chokepoint – Bloomberg. (Why you should care – tankers laden with at least 8 million barrels of oil transited the route along the Omani coast line, which the U.S. has shown it is capable of defending)

Iranian President Masoud Pezeshkian expressed optimism that talks with the U.S. could provide a strong basis for economic growth; he said the first goal of the negotiations was restoring access to some of Iran's frozen assets – Reuters. (Why you should care – the U.S./Iran memorandum of understanding foresees 60 days of talks on issues such as curbing Iran's nuclear program in return ​for the lifting of international sanctions)

Iran has resumed loading crude from its Kharg island export terminal after a break of about six weeks, following the lifting of a U.S. Navy blockade of its ports; three very large crude carriers, each capable of hauling about 2 million barrels of crude, are moored at the Sea Island terminal to the west of Kharg – Bloomberg. (Why you should care – the ship loading indicates Iran looks to press forward with increased oil exports)

European Central Bank Governing Council Member Pierre Wunsch said he wouldn’t be surprised to see oil prices drop below pre-war levels over the next 12 months; Wunsch said he believes there could be a global oil supply glut in 2027 – Reuters. (Why you should care – a steady decline in oil prices would help to lower prices at the gas pump and headline inflation growth)

Economic Calendar:

China – PBoC Loan Prime Rate for June

ECB’s Lagarde (President) Speaks (6 a.m.)

ECB’s Nagel (Germany) Speaks (7 a.m.)

ECB’s Lagarde (President) Speaks (8:30 a.m.)

Fed’s Waller (Board Member, Voter) Speaks (9 a.m.)

Eurozone – Consumer Confidence for June (10 a.m.)

ECB’s Lane (Chief Economist) Speaks (10:10 a.m.)

ECB’s Lagarde (President) Speaks (11:15 a.m.)

Treasury Auctions $89 Billion in 13-Week Bills (11:30 a.m.)

Treasury Auctions $77 Billion in 26-Week Bills (11:30 a.m.)

U.S. - CFTC’s Commitment of Traders Report (3:30 p.m.)

Japan – Au Jibun Bank Japan Manufacturing, Services, Composite PMI (Preliminary) for June (8:30 p.m.)