It is highly likely that inflation peaked in May, given the sharp 38.8% decline in West Texas Intermediate oil prices from its May apex, so one should expect a negative month-over-month print across the June inflation data.
This means the 0.4% month-over-month increase and 4.1% advance in inflation from one year ago is a stale number.
What is not stale is the increase in core inflation of 0.3% and 3.4% over the past 12 months, which will not retreat so easily. Core inflation is up 4% on a three-month annualized basis. Given the clear pipeline pressure that has been evident for the past few months inside the Producer Price Index—unlike the topline—those prices will not so easily retreat.
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It is clear that the AI infrastructure buildout will put pressure on core and topline inflation going forward. Additionally, the coming increase in defense spending to replenish the weapons stock and address the revolution in military affairs around drone and robotic warfare—which will draw on many of the same resources that are in demand from tech companies to support the AI buildout—will compound this pressure.
Although those oil prices will eventually feed through to lower gasoline prices to provide relief to beleaguered down market American consumers (the upper two quintiles of consumers are doing just fine) one should not anticipate a return to pre-war levels of inflation any time soon.
This means a rate hike is far more likely than a rate cut out of the Federal Reserve in the near term. While we do not have a good sense of the Fed’s reaction function—no honest individual does currently—a variety of models of the optimal interest rate for the U.S. economy that we utilize all suggest that monetary policy is currently accommodative.
Therefore, it is a difficult judgement call on whether rates should remain on hold or whether a hike in the federal funding policy rate is appropriate given current inflation dynamics.
The data
The drop in oil prices and resulting easing in topline inflation will provide relief in the coming months.
However, if one adjusts the current level of income for inflation, it was revised down to flat in April and is up 0.3% in May—in contrast to the 0.7% nominal increase on the month and the 0.7% increase in spending.
This implies Americans drew upon savings—the rate is at 3% in May compared to 4.4% in January—and utilized credit to support their individual levels of spending and to make ends meet.
If one adjusts wage gains based on the PCE data, it implies a 0.7% decline in real wages from May of 2025. Consistent with our work on demand destruction and supply shocks, we think that a transitory period of demand destruction in the U.S. peaked in May.
That stands in contrast with the more pronounced demand destruction in Europe and Asia that appears more structural in nature and is part of a broader narrative around why global oil prices have adjusted down quickly over the past several weeks.
Compensation, wages and salaries increased 0.4% while disposable income advanced 0.4%. On an inflation-adjusted basis, personal income increased 0.3% as did disposable income.
Goods prices increased 4.8% from one year ago in May—those tariffs have not yet worked their way through the economy yet—as durable prices advanced 3.3% and non-durables 5.6%.
Service prices are up 3.8% from one year ago compared to 3.5% previously. Food prices are up 2.4% and energy costs are up 24.3% over that same time period.
The takeaway
Combined demand destruction across the global economy—structural in Europe and Asia while transitory in the U.S.—along with a flood of oil and refined product supply now flowing out of the Persian Gulf has caused a return to pre-war price levels in Brent crude and stand just above those levels in West Texas Intermediate.
That development will set the stage for a sharp decline in topline inflation in June 2026.
However, as one can observe inside the data that sticky service sector inflation, a sustained increase in goods inflation caused by tariffs, current pricing pressures due to the AI infrastructure buildout and coming pricing pressures that will be linked to defense spending will contribute to a challenging core inflationary picture going forward.
This means a much more hawkish Federal Reserve, so a rate hike remains far more likely than a rate cut in the second half of the year.
