Inflation Shows Further Cooling: June Core PCE Below Expectations

The U.S. Commerce Department released data on July 26 showing that the annual rate of the core Personal Consumption Expenditures (PCE) price index for June was only 2.3%, not only below the market expectation of 2.5% but also down from 2.6% in May. On a monthly basis, core PCE rose just 0.1%, also lower than the estimated 0.2%. This unexpected softening of the Fed's most-watched inflation gauge immediately triggered a strong reaction in financial markets.

Market Euphoria: Rate Cut Expectations Rise, U.S. Stock Indices Hit Record Highs

Following the data release, all three major U.S. stock indices rallied. The Dow Jones Industrial Average rose about 350 points, the S&P 500 gained 1.2% to approach the 7,800 level, and the Nasdaq surged 1.8%, with tech stocks performing particularly strongly. In the bond market, the 2-year Treasury yield fell 8 basis points to 4.12%, while the 10-year yield dropped to 4.35%, reflecting sharply increased market expectations for a faster pace of Fed rate cuts.

According to the CME FedWatch tool, traders now see a 78% probability of a quarter-point rate cut in September, up from 55% before the data release, and discussions have begun about a possible further cut in November. Some Wall Street analysts believe that if inflation continues to cool, the Fed may act decisively at its September meeting to provide more support for the economy.

Expert Analysis: Is a Fed Policy Shift Imminent?

Ellen Zentner, chief U.S. economist at Morgan Stanley and a renowned economist, said: "This PCE report almost confirms that the Fed will begin a rate-cutting cycle in September. Although the labor market remains solid, inflation pressures have eased significantly, and the Fed has no reason to keep rates restrictive." She added that the core PCE annual rate is now only 0.3 percentage points away from the Fed's 2% target, and given the lagging effects of rent and services prices, a further decline in the coming months is highly likely.

However, some hawks remain cautious. Peter Hooper, a former Fed official and now a professor at Yale University, cautioned: "A single month's data does not make a trend. The Fed needs to see several consecutive months of cooling inflation to be convinced. July and August data will be key." He believes the market may be overly optimistic and that the Fed is more likely to wait until December for its first rate cut.

Capital Flows: Tech Stocks Regain Favor, Energy and Healthcare Follow

The rising rate cut expectations directly boosted growth stocks, particularly tech giants. Apple, Microsoft, and Nvidia each rose over 2%, with Nvidia alone adding more than $50 billion in market value in a single day due to optimism about sustained AI demand. The Philadelphia Semiconductor Index climbed 2.5%, hitting a new record high.

Beyond tech, the energy and healthcare sectors also performed well. Energy stocks benefited from stabilized oil prices and expectations that rate cuts could stimulate economic activity, with Exxon Mobil and Chevron rising 1.5% and 1.3%, respectively. Healthcare stocks drew inflows due to lower rates favoring highly indebted biotech companies and a recent uptick in M&A activity, with Johnson & Johnson and Pfizer each gaining over 1%.

Defensive sectors such as utilities and consumer staples lagged, indicating a clear increase in risk appetite. Analysts note that once rate cuts officially begin, capital may shift further from safe-haven assets to risk assets, sustaining the bull market in U.S. stocks.

Investment Strategy: Focus on Rate-Sensitive Groups, Position for Rate Cut Beneficiaries

For investors, the cooling of core PCE offers new opportunities for positioning. First, rate-sensitive groups such as real estate, financials, and utilities are likely to benefit directly. Lower rates will reduce financing costs for real estate investment trusts (REITs) and enhance their dividend appeal; banks will gain capital appreciation from rising bond prices, and loan demand may pick up.

Second, small-cap stocks often outperform during rate-cutting cycles. The Russell 2000 has risen about 5% in the past month, and analysts see potential for double-digit gains over the next six months. Investors can participate via index ETFs like IWM or actively managed funds.

Finally, tech stocks remain a core allocation, especially in AI, cloud computing, and semiconductors. Rate cuts not only lower tech companies' cost of capital but also increase the present value of future earnings. Recommended stocks for pullback additions include Nvidia, AMD, and Broadcom, which benefit from AI capital expenditures.

Risk Warning: Don't Ignore Geopolitics and Inflation Rebound

Despite the market euphoria, investors should remain cautious. Geopolitical risks such as the Middle East situation and U.S.-China tech competition could trigger volatility at any time. Additionally, if oil prices spike due to supply disruptions or services prices resume rising, inflation could flare up again, forcing the Fed to delay rate cuts. In asset allocation, it is advisable to maintain 5%-10% in safe-haven assets such as gold or short-term Treasuries to cope with unforeseen events.