Imminent CPI Report: Pivotal Inflation Showdown Could Halt Fed's Rate Hikes

The last mile is always the hardest. The Bureau of Labor Statistics will reveal the much-awaited consumer price index (CPI) inflation report on Tuesday, June 13, coinciding precisely with the kickoff of the Federal Open Market Committee’s two-day rate-setting meeting.

The convergence of all the essential economic elements sets the stage for market fireworks next week.

Investors widely expect the Fed to pause its rate-hike campaign in June, assigning a 73% probability to this scenario, according to the latest CME Group FedWatch tool. Rising expectations on a Fed rate pause have been one of the key factors driving the S&P 500 Index, tracked by the SPDR S&P 500 ETF Trust SPY, to cross the bull market threshold in June.

But the Federal Reserve’s decision to hold off on rate hikes in June, in line with market expectations, necessitates a restrained or inline inflation reading. Yet, a lingering concern arises: what if inflation defies expectations and surprises to the upside?

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May CPI Preview: What The Economists’ Consensus Expects

Economists’ expectations for the May CPI report are optimistic, with the consensus pointing to a continued slowing in consumer price pressures.

• The headline annual inflation rate is expected to fall significantly from 4.9% in April to 4.1% in May, according to forecasts. If the expectations are correct, it will be the lowest inflation reading since March 2021.
  
• On a monthly basis, headline inflation is predicted to advance by a modest 0.2% from April, signaling a sharp deceleration from the previous 0.4% rise.
  
• As for the core annual inflation rate, which excludes energy and food components from the CPI basket, a decline from 5.5% in April to 5.3% in May is anticipated. Should this consensus view materialize, it would mark the lowest core inflation rate since November 2021.
  
• On a monthly basis, core inflation is predicted to advance by only 0.4% from April, maintaining the trend observed so far in 2023.

Chart: US Inflation Rate vs Core Inflation Rate

Inflation Surprises May Spark Bold Fed Reactions

ING Group‘s chief economist, James Knightley, suggested that a higher-than-expected core CPI reading of 0.5% in next Tuesday’s report could sway enough FOMC members to vote for a rate hike. “The Fed aims for monthly CPI readings of 0.2% or below to be confident in inflation returning to 2%,” the economist said. If rates are held steady, it is likely to be a hawkish hold, leaving the door open for future rate hikes if inflation persists.

According to Citigroup analyst Andrew Hollenhorst, a core CPI reading of 0.4% monthly in May could cause a rate hike. This print would necessitate a revision of the Fed’s core inflation outlook. Despite being against consensus, Citigroup thinks a 25-basis-point rate hike would be consistent with the Fed’s data-driven strategy.

Goldman Sachs economists, led by Jan Hatzius, believe that while Core PCE inflation has not fallen as much as expected, a considerable deceleration is expected later this year. This “normalization of inflation psychology” should relieve Fed policymakers’ sense of urgency, even if realized inflation falls slowly. The investment bank forecasts a significant slowdown in inflation during the second half of 2023, owing to lower housing costs and lower car prices.

Bank of America holds a consensus view on the May’s CPI report. The bank’s expectation for a soft headline print is due to a forecasted decline of 3.0% monthly for energy prices as gas prices fell in May. In fact, statistics from the American Automobile Association (AAA) illustrate a 2.1% month-over-month decrease in average regular gasoline prices.

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