Key insights
- Headline CPI hit a 3-year high of 4.2% in May, driven by energy prices. However, core CPI rose less than expected (0.2% MoM, 2.9% YoY), indicating some moderation in underlying inflation. While energy costs remain a significant driver, slower price growth in other categories offers a mixed but slightly positive signal for the Fed, suggesting inflation may not be as persistently broad-based as headline figures suggest.
Year-over-year headline inflation hit 4.2% in May, the first time the Consumer Price Index (CPI) has topped 4% in three years.
But beneath the surface, the prices on several consumer goods and services declined, which is good news for Kevin Warsh as he kicks off his tenure as the new chair of the Federal Reserve’s influential Board of Governors.
The CPI rose 0.5% in May from the prior month, putting both headline inflation and the monthly increase in line with economists’ estimates.
Core CPI, which strips out more volatile food and energy prices, rose 0.2% from the prior month and 2.9% year over year. The monthly increase came in 0.1% below economists’ estimates.
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The bulk of what’s driving the large increase is energy prices, which have been much higher since the start of the Iran war and the closure of the Strait of Hormuz, a critical waterway for global oil supply.
In May, energy prices rose another 3.9% from the prior month, following monthly increases of 10.9% and 3.8% in March and April, respectively.
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But if you look at some of the other categories, price growth slowed in May from April:
Now, investors should remember that the prices of some of the above items have continued to rise, meaning prices are still increasing on top of what have already been some pretty steep increases this year, so consumers are still grappling with affordability issues.
And this doesn’t mean Americans are out of the woods yet either.
“Americans are getting squeezed financially by inflation that’s back at a 3-year high,” said Heather Long, chief economist at Navy Federal Credit Union, according to CNBC. “The frustration for many Americans is that so many of the basics are up in price right now -- gas, food, electricity, and medical care are all clear pain points that are above 3% inflation. Ending the war in Iran will help to moderate inflation, but the worst is likely still to come for rising food prices.”
Following the May CPI report, traders betting on changes to the Fed’s overnight benchmark lending rate, the federal funds rate, through 30-day fed funds futures, slightly decreased the likelihood of a rate hike at the Fed’s December meeting.
That’s the first meeting the market expects the Fed to hike at, but the likelihood of such an event decreased from 43.3% to 42.7%, as of this writing. Keep in mind that these probabilities change frequently.
Warsh has said on numerous occasions now that he wants to change the lens through which the Fed views inflation.
“The measures I prefer are looking at things that are called trimmed averages, where we take out all of the tail risks, all of the one-off items, and we ask ourselves whether the generalized change in prices is having second-order effects on the economy,” Warsh said during Congressional testimony in April. “Again, they're not where they should be, but I think that the trend is quite favorable.”
I think the May CPI shows that, while inflation is high, it’s largely driven by energy, which is more of a one-off item with some tail risk if the Iran war is prolonged.
Earlier this month, there was also a strong jobs report, which is what you want to see if you’re the Fed: the labor market improving and core inflation coming down.
So I think Warsh is likely to find a lot to like in this report. It doesn’t necessarily give him enough to cut interest rates, but it’s likely enough to keep taking a wait-and-see approach and hope the Iran war ends soon, so the global oil supply chain can normalize.