Inflation has reached its highest level in more than three years. At the same time, American wages are falling behind. In other words, prices are rising, but purchasing power is not. And as if that were not enough, markets are now fearing something that just a few months ago would have sounded crazy: not only that interest rates will not be cut, but that they might actually need to go up.
WHAT THE REPORT SHOWED
So, first the numbers. The overall Consumer Price Index rose 0.5% in May. On an annual basis, it reached 4.2%.
To understand what that means, this is the highest reading since April 2023. Inflation has moved above 4% for the first time in three years.
And who is responsible for all this? Energy alone accounts for more than 60% of the increase. Energy prices rose 3.9% in one month, and on an annual basis they are up 23.5%. Gasoline alone increased 7%. And you know why. The war in Iran has pushed oil prices sharply higher.
But here is the interesting part. If we exclude energy and food, the so called core CPI rose only 0.2% on the month, lower than in April. This means the problem is mainly energy driven, not broad based. Food rose only 0.2%, rents increased 0.3%, while new cars fell 0.3% and auto insurance premiums dropped 1.7%. Even core goods fell 0.1%. However, airline tickets rose 2.7%, a sign that higher oil prices are gradually spreading into other parts of the economy.
FORGET RATE CUTS
And now to the most important part, the part that changes everything. Until recently, everyone was waiting for the Federal Reserve to start cutting interest rates. That is over. With inflation at 4.2% and moving further away from the 2% target, rate cuts are completely off the table.
The Fed meets on June 16 and 17. This will be the first meeting under the new chair, Kevin Warsh. Everyone expects rates to remain unchanged. So far, so good.
The problem is what comes next. Markets are now pricing in something nobody wanted to hear: that the Fed’s next move could be an interest rate hike later this year, possibly in December.
Yes, you read that correctly. A hike, not a cut. Joseph Brusuelas from RSM said it clearly. The Fed is, in his words, “hostage to developments in the Middle East.” If the war continues and oil supplies remain under pressure, the Fed may be forced to raise rates in the autumn. Gregory Daco from EY-Parthenon warns that as long as the conflict continues, inflationary pressure will become broader and more persistent.
Of course, there is a big “however.” Some analysts, such as David Russell from TradeStation, also see positives. They argue that rents and car prices are declining in the long term, and that unless energy spikes again, a rate hike might be avoided. Even Bloomberg Economics estimates that inflation likely peaked in May. So yes, not everything is negative. But the overall mood has completely changed.
