Tensions between Israel and Iran escalated over the weekend, driving oil prices sharply higher. Brent crude rose as much as 5.5% during early Asian trading, fueled by continued mutual attacks on each other’s territory. Last week, Israel conducted airstrikes on Iran’s nuclear facilities and military leadership, followed by an attack on the South Pars gas field in the Persian Gulf, forcing the shutdown of a production platform.
Meanwhile, recently released data indicated that tariffs have not significantly impacted prices, and U.S. inflation data showed further signs of easing, rekindling expectations for rate cuts later this year. May’s Consumer Price Index (CPI) data revealed a further softening in inflationary pressures, with particularly subdued growth in core inflation. Month-over-month, CPI rose 0.1%, below both the market expectation and previous reading of 0.2%. Year-over-year, CPI rose 2.4%, in line with expectations and slightly above April’s 2.3%. Core CPI rose 0.1% month-over-month, notably below the forecasted 0.3% and April’s 0.2%; the year-over-year core CPI came in at 2.8%, under expectations of 2.9% and flat compared to the previous month.
The moderation in May’s CPI was primarily driven by declines in energy and select goods prices. The subdued growth in core inflation suggests easing pressure on service prices, possibly reflecting stable consumer demand or tighter corporate cost controls. Notably, after two strong months at the beginning of the year, core inflation has now come in below expectations for three consecutive months, indicating a continued deceleration in underlying inflation—even beyond the upside risks posed by tariffs.
Later-released Producer Price Index (PPI) data also surprised to the downside. May PPI rose 2.6% year-over-year, in line with forecasts; however, core PPI increased only 3.0%, the lowest reading since August 2024 and below the expected 3.1%. The softer-than-expected CPI and PPI readings significantly influenced financial markets and monetary policy expectations. Like the CPI, PPI has shown a relatively mild trajectory in recent months. While May’s PPI may not fully capture the impact of tariffs, overall inflationary pressures remain moderate, with some signs of weakness in the services sector.
Additionally, the University of Michigan’s preliminary Consumer Sentiment Index for June came in at 60.5, the largest monthly increase since January 2024 and above both the expected 53.6 and the prior reading of 52.2. One-year inflation expectations fell to 5.1%, the largest monthly decline since October 2001, beating the expected 6.4% and April’s 6.6%.
Taken together, last week’s data broadly indicated easing inflation, providing the Federal Reserve with greater policy flexibility. While markets still widely expect the Fed to hold interest rates steady at the June 2025 meeting, expectations for rate cuts in the second half of the year have increased. Futures markets are now implying more than two cuts by year-end.
What surprised markets even more was the strong demand seen in the $22 billion 30-year U.S. Treasury auction, despite increasing caution toward long-term bonds and yields approaching 20-year highs. The auction cleared at a yield of 4.844%, the highest since January but about 1.5 basis points lower than the prevailing market level before the auction—suggesting investors were willing to accept lower yields to absorb the entire issuance. Alongside a solid 10-year auction earlier in the week, this indicates no significant loss of confidence in U.S. Treasuries overall.
Nevertheless, fiscal pressures persist. The U.S. posted a May budget deficit of slightly over $316 billion, down 9% year-over-year. For the current fiscal year (October 1, 2024–May 31, 2025), the total deficit has reached $1.4 trillion, a 14% increase from the same period last year. Although May showed marginal improvement, this was largely due to base effects; the overall trend still points to steadily worsening deficits.
Federal debt now stands at $36.2 trillion, with the weighted average interest rate remaining elevated at 3.28%. Interest payments in May reached $92 billion, accounting for 29% of the monthly deficit and representing the largest single driver of deficit growth. Tax revenues rose 15%, with tariff income surging 270% to $23 billion. However, these gains were more than offset by rigid expenditure growth in healthcare, social security, and defense spending, with the high interest burden further squeezing fiscal space.
This week, the Federal Reserve will hold its policy meeting and release the latest Summary of Economic Projections (SEP). While markets are nearly certain that the Fed will keep rates unchanged, whether it signals a potential rate cut in the third quarter will be the main focus of the meeting. Overall, the next rate cut by the Fed no longer seems far off.