The drop in inflation in June paves the way for the US economy to avoid a recession, former PIMCO chief economist says

• The drop in inflation is strengthening the case the US will avoid a recession, economist Paul McCulley said.
• The former chief economist of PIMCO pointed to June CPI, which showed inflation eased to 3%. 
• Cooling prices in the economy is exactly what the Fed and markets want to see, he said.

The June inflation report is making the case that the US economy can avoid a recession after all, according to PIMCO's former chief economist Paul McCulley.

McCulley pointed to the Consumer Price Index report on Wednesday, which showed prices slowing to just a 3% year-over-year increase last month. That's the lowest inflation reading in over two years, and it's well-below where prices were in July 2022, when headline inflation clocked in at 8.5%.

The drop in inflation is strengthening the case that the US can avoid a recession after all, despite markets eyeing an imminent downturn for most of the past year.

"This is the stuff of a soft landing. This is what the Fed has been looking for. This is what the market wants to see," McCulley said in an interview with CNBC on Wednesday. 

The Fed is still likely to raise interest rates at its next policy meeting, with markets pricing in a 95% chance officials will hike rates another 25 basis-points at the end of this month. Experts have warned high rates in the economy could push the US into a downturn, especially considering that the full impact of rate hikes takes months to be felt throughout the economy. 

But central bankers will need to hike rates to cement their credibility on inflation, McCulley said, and another rate hike is unlikely to be the factor that pushes the US into a recession. That's because the lagged effect of monetary tightening could be easily be combated with rapid rate cuts if economic growth appears to be stagnating.

He predicted central bankers would begin to trim interest rates once they saw a cooler labor market and more disinflation in the economy.

"I think the Fed's got a lot of room to make it happen. They don't have to stay high as long as they think if it turns out that the lags are nastier than we think," McCulley said.

Other commentators have turned more positive on the economy and markets as inflation continues to cool without sparking significant weakness in the labor market. Some say the economy is showing signs of entering an expansion, which could help stocks continue their rally.