Last Friday, the most awaited market-moving economic data, the consumer price index (CPI) inflation reading for the month of May, was released in the US. The inflation data came in hotter than expected, with the headline figure coming in at 8.6% on a yearly basis, above expectations of 8.2%, while core CPI (excluding food and energy) came in at 6.0%, marginally above the 5.9% forecast but confirming that the pace of that moderation is proceeding more slowly than hoped. This month, the differential between headline and core inflation was the widest seen in the past 10 years.
The key drivers of inflation remain the rising global food and energy prices. With uncertainty about the Ukraine war still lingering and weighing heavily as well as China's slow reopening and dropping industrial demand, commodity prices may remain stubbornly elevated over the next several months.
However, the Federal Reserve's actions in raising rates and quantitative tightening do not impact global commodity prices or the demand for consumer staples, like food and energy. Its focus can only be on fighting core inflation. Its focus can only be on fighting core inflation. A modest moderation was seen in the report but shelter and used car prices remain high. Nonetheless, the higher mortgage rates (5.4% over 30 years) have started to cool the housing market, which will over time impact on the shelter/rent components of CPI and early signs of layoffs in areas like the retail and technology sectors may eventually cool the sticky influence of wage growth.
For now, the Fed can only go at full speed on its aggressive path as it has already endorsed a 0.50% rate hikes for the June and July meetings. As at today, the CME Group’s Fed Watch tool, which had been strongly pointing to a 50 basis point hike this week, was showing a 96% probability of a 75 basis point move. Other major banks are even pricing another 0.75% increase through July and 0.50% in September though data-dependence will remain key and to note that there are three additional CPI readings ahead of the September 21 FOMC meeting. We are of the opinion that a more aggressive tone will provide more comfort to the markets and regrettably, only an economic contraction and a slowdown in employment will bring inflation down to more tolerable levels.