Top-line inflation advanced by 0.5% in May, resulting in a 4.2% increase from a year ago, the Labor Department reported on Wednesday,
The increase marked the first time that the consumer price index had risen by more than 4% in more than three years. The surge was driven by energy prices overall, which rose by 3.9% on the month; gasoline, which increased by 7%; transportation, by 1.3%; and airfares, by 2.7%.
Core inflation, which excludes the more volatile food and energy components, increased at a 0.2% pace in May and was up by 2.9% over the past year.
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But more important, inflation in May outpaced wage gains for the second consecutive month, resulting in a decline of 0.7% in real wages, which account for inflation.
While upper-end consumers will continue to keep overall spending at acceptable levels—as seen in the 1.4% gain in household consumption for the first quarter—declining real wages among middle-class, working-class and working-poor households will slow spending in the second half of the year.
In the immediate aftermath of the most recent supply shock, we changed our forecast for CPI to peak at 4.5%.
We are quite comfortable with that forecast because of our expectation that we have not yet experienced the complete pass through of higher energy prices or higher costs related to the red-hot buildout of AI infrastructure.
That buildout is raising the cost of everything from software to intellectual property to computer hardware. And whether it’s sulfur, helium or bromide, used in the manufacturing of semiconductors and chips, or the new sources of demand within the tech ecosystem, we think that pricing pressures have not yet abated, nor will they anytime soon.
Policy implications
Market players are already pricing in one 25 basis-point rate increase from the Federal Reserve by the end of the year with the expectation that the Fed will remove the easing bias from its policy statement at the end of its two-day meeting on June 17.
With the yield on the two-year Treasury standing at 4.13%, well above the upper end of the Fed’s 3.5% to 3.75% policy range, the Kevin Warsh era at the Fed will be defined by a market-induced policy tightening as the central bank risks falling further behind the curve on inflation.
The May CPI supports those market expectations, and we anticipate the Fed to adopt a hawkish hold on rates at its next meeting.
At this point, the Fed has little choice but to hold rates steady as the war in the Middle East plays out. The period in which oil and energy buffers continue to dampen global spot pricing is the major factor here in my estimation.
Should the draw down of inventories continue resulting in rising operational stress, then the Fed will be pushed into hiking the policy rate this fall.
Such an increase would spur the Fed’s central banking brethren at the European Central Bank and the Bank of England to lift their policy rates as well.
The data
Over the past year, energy prices surged by 23.5%, energy commodities by 40.6% and gasoline by 40.5%. That is probably the best summation of a war-induced supply shock and why we think that we have not yet experienced a compete passing through of the price shock downstream.
Service-sector prices increased by 0.3% on the month and were up by 3.5% from a year ago. Housing costs rose by 0.2% monthly while the shelter and owners’ equivalent rent series both rose by 0.3%. On a year-ago basis, they were up by 3.6%, 3.4% and 3.3%, respectively.
Fuel and utility prices increased by 6.0% from a year ago.
Food and beverage costs increased by 0.2% on the month and were up by 3% from a year ago. Transportation costs increased by 1.3% in May and were up by 9.3% over the past year. New-vehicle prices fell by 0.3%, and used cars and trucks advanced by 0.1%.
The price of beef and veal increased by 12.9% from a year ago. Fish and seafood were up by 6.5% annually while the cost of poultry advanced by 1.3% over that same period. The cost of fresh fruits and vegetables increased by 6.7% over the past 12 months.
Airfare prices rose by 26.7% from a year ago while recreation costs both increased by 2.6% over that same period. Apparel costs increased by 0.3% monthly and by 4.8% annually.
The takeaway
Inflation in May pushed past 4% for the first time in more than three years because of rising energy, gasoline, transportation and airfare costs.
That increase outpaced wage growth, resulting in a decline of 0.7% in real wages, which will further sour consumer sentiment and pose a risk to household consumption in the second half of the year.
The May CPI feeds into expectations that the Federal Reserve will be on hold with rate cuts until the Strait of Hormuz reopens to shipping.
Until then, the risk of rising inflation is titled toward higher prices as higher costs are passed along downstream and as the AI infrastructure buildout remains red hot.
