A hot inflation reading for May released Wednesday morning reinforces that the Federal Reserve will maintain interest rates next week. Rates will likely remain on hold until there’s evidence that inflation is receding.
The Consumer Price Index rose 4.2% in May, in line with expectations, compared with 3.8% in April. The increase was again driven by energy prices due to the conflict in the Middle East, which accounted for 60% of the rise in inflation. Food and shelter prices also pushed up inflation last month.
Stripping out volatile energy and food prices, “core” inflation ticked up to 2.9% from 2.8% in April, also in line with expectations. Month over month, core inflation rose 0.2%, below expectations for a rise of 0.3% and down from 0.4% in April.
Officials are closely watching whether higher energy prices are becoming embedded in core inflation. So far, core prices have not jumped at the same level as energy prices. Still, core inflation ticked up and is roughly a full percentage point above the Fed’s 2% inflation goal.
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Stephen Brown, chief North America economist for Capital Economics, said the rise in core CPI “was not as bad as we feared and the move was relatively narrow in nature, which should reassure the FOMC that price pressures are not broadening.”
Brown noted that the details were “as good as the more dovish FOMC members could have hoped for.” Core goods prices fell 0.1% month over month in part due to lifted tariffs. The only major concern for the central bank might be that housing prices are up, per Brown.
None of this is “large enough to provide any ammo for the FOMC hawks ahead of Kevin Warsh’s first meeting as Chair next week,” Brown said.
The report comes one week before the Fed will hand down its first interest rate decision under the leadership of newly minted Chair Kevin Warsh.
Most Fed officials favor holding rates steady for now, with a growing chorus looking at a rate hike if inflation becomes persistent.
The yield on the 2-year Treasury remains around 4.1% Wednesday morning, the same as in recent weeks. This essentially prices in a 25 basis point rate hike, given the yield is above the Fed’s 3.5% to 3.75% policy rate.
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“The Kevin Warsh era at the Federal Reserve is going to be defined by a market induced policy tightening as the central bank risks falling further behind the curve on inflation,” RSM chief economist Joseph Brusuelas said.
