What To Expect From The Fed After May CPI Numbers?

US inflation accelerated to a fresh 40-year high in May, a sign that price pressures are becoming entrenched in the economy. The consumer price index increased 8.6% from a year earlier in a broad-based advance, Labor Department data showed on Friday. The widely followed inflation gauge rose 1% from a month earlier, topping all estimates. Shelter, food, and gas were the largest contributors. Economists from the Wall Street Journal expected the consumer price index to rise 8.3% in May. The core CPI, which strips out the more volatile food and energy components, rose 0.6% from the prior month and 6% from a year ago, also above forecasts. 

Fed officials are watching for signs that inflation is cooling on a monthly basis as they try to guide price increases back down to their goal, but Friday’s report offered more reason for worry than comfort. The headline inflation rate was the fastest since late 1981, as a broad array of products and services including rents, gas, used cars and food became sharply more expensive.


In May, prices for necessities continued to rise at double-digit paces. Energy prices climbed 34.6% from a year earlier, the most since 2005, including a nearly 49% jump in gasoline costs. Gas prices so far in June have climbed to new highs, signaling more upward pressure in coming CPI reports and therefore keeping the Fed in the hot seat. Grocery prices rose 11.9% annually, the most since 1979, while electricity increased 12%, the most since August 2006. The rent of primary residence climbed 5.2% from a year earlier, the most since 1987. Used car prices, which had been cooling in recent months, advanced 1.8% in May, the most this year. New-vehicle prices climbed 1%. Airfares rose 12.6% in May, a slight moderation from the prior month but still up the most on an annual basis since 1980. Prices for hotel stays, meanwhile, were up 22.2% year-over-year. Rising demand for travel and entertainment this summer, particularly among wealthier households who have the savings to support discretionary spending, as well as, tight labor market conditions will likely maintain upward pressure on services inflation in the coming months. 



The Fed’s attempt to temper inflation by slowing down the economy is contributing to an already sour economic mood. Consumer confidence has been sinking all year as households shoulder the burden of higher prices, and President Biden’s approval ratings have also suffered. Both Wall Street economists and small business owners increasingly worry that a recession is possible in the next year. 

The dollar climbed to a near four-week high against a basket of currencies on Friday. The index was up nearly 2%, its best weekly performance in 6 weeks. Stocks sold off sharply on Friday, with the S&P 500 closing down 2.9 % in New York and the Nasdaq Composite dropping 3.5 %. Short-dated US government bonds, which are most sensitive to monetary policy changes, sold off sharply as well. The yield on the two-year Treasury note climbed above 3 %, the highest level since 2008. The S&P500 is down 10 of the last 11 weeks, the worst stretch since the Great depression. 



While some economists see the Fed’s rate-hike regime is  likely to push the US economy into a recession, El-Erian, a Bloomberg Opinion columnist, says that is his “risk scenario. Stagflation is my baseline. Be careful what you wish for. If you believe the labor market stays strong, wages remain buoyant and start catching up to inflation, then it’s hard to see inflation coming down,” he said. “But if you think we’re going to have a recession, sure, inflation is going to come down, but that’s not the sort of transitory inflation that anybody wants.” 

Friday’s hot reading increase the odds of a September 0.50% rate hike. Markets are now pricing in a 62% probability of a 0.50% rate hike and a 33% chance that the Fed moves aggressively with a 0.75% rate hike 


Lael Brainard, the vice-chair, recently made clear that the Fed could continue the half-point pace into September and would only consider reverting to more typical quarter-point increments following a “deceleration” in monthly inflation prints.

The Central Bank’s benchmark short-term borrowing rate is currently anchored around 0.75%-1% and is expected to rise to 2.75%-3% by the end of the year, according to CME Group estimates. In March, the median dot for year-end was 1.9%. Economists surveyed by Bloomberg see it rising to 2.6%, while market-implied expectations put it at 3.2%.

The market now prices three 50bps hikes and 2 more small steps. Now a key interest rate of almost 3% at the end of the year is priced in.



The content published above has been prepared by CFI for informational purposes only and should not be considered as investment advice.  Any view expressed does not constitute a personal recommendation or solicitation to buy or sell.  The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it, and is not held out as independent investment research and may have been acted upon by persons connected with CFI.  Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients.