A 1% decline in energy prices, a 2.6% drop in gasoline costs and modest declines in vehicle costs restrained the increase in the May consumer price index, which will provide at least temporary relief for consumers who pulled forward spending to avoid the rising costs linked to trade policy.
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The best aspect of the May CPI report released on Wednesday was that excluding food, energy and shelter, inflation did not increase and was up by 1.9% from a year ago.
Under normal circumstances, that would be a reason to celebrate and talk about future Federal Reserve rate cuts. But that is not the case with trade taxes imposed on imports and firms almost certainly accepting narrower profit margins as they absorb the costs of those tariffs.
Tariffs: An emerging sketch
Early in the post “Liberation Day” environment, it is likely that firms are choosing to absorb some of the costs of tariffs rather than immediately passing them along, which is not beneficial to corporate earnings.
In addition, negotiation along supply chains to reduce costs and the pulling forward of inventories allowed some firms—most notably auto producers—to sell at reduced costs even as new production and inventory will have rising costs attached to them.
But with an effective tariff rate of 15.6% and a dollar that has declined by 7.8%, that scenario will not endure indefinitely.
Tariff-sensitive goods like apparel, electronics and toys have risen by 0.4% since the beginning of the year and consumer electronics have increased by 0.5% over that same period.
The price increases will be passed along, and one can see an emerging sketch inside the May data as core goods moved from deflation to a 0.3% increase in May.
The cost of appliances increased by 4.3%, laundry equipment by 2.3%, while audio equipment advanced by 1.6% following an 8.8% price increase previously.
Canned food prices—think steel and aluminum tariffs—increased with canned fruit prices up by 1.1% and canned vegetables increasing by 2.6%.
Toy prices—think imports from China—increased by 1.3%, personal computers by 1.1% and photographic equipment and supplies by 1.6% following a 2.2% advance in April.
The Fed, given its well-signaled framework for approaching the trade shock, will look right through the data will the knowledge that those prices will narrow margins if eaten, unless the higher costs are passed downstream to American consumers.
Do not anticipate any signal of a summer rate cut inside the Fed’s Summary of Economic Projections or the central bank’s interest rate projections, called the dot plot, at its policy meeting on June 18.
The data
Service prices increased by 0.2% and were up by 3.7% from one year ago while housing costs advanced by 0.3% and by 4% on a year-ago basis.
Shelter and the policy-sensitive owners’ equivalent rent advanced by 0.3% each and were up by 3.9% from one year ago in the former and by 4.2% in the latter.
Food prices increased by 0.3% on the month and 2.9% over the past year.
While categories that were expected to increase saw notable declines such as the 0.4% drop in apparel and the 0.7% fall in transportation costs, the latter was driven by a 0.5% drop in used cars and trucks and a 0.3% decline in new vehicles prices.
In areas where prices declined, airline fares dropped by an outsized 2.7%.
Medical care costs advanced by 0.3%, recreation increased by 0.1% and commodity prices dropped by 0.1%.
The takeaway
The inflation data early in the current trade war has not yet captured the domestic price adjustment that will inevitably arrive. For now, the recent decline in energy and gasoline prices as well as a more moderate pace of rising service costs provided enough of an offset to restrain the increase in overall inflation in May.
But once one digs beneath the surface, one can see an emerging sketch of how inflation will increase across the economy linked to steel and aluminum costs as well as a broad array of consumer goods.
