Fed Gets Cover From CPI to Hold Interest Rates for Now

The newest CPI report shows inflation continuing to slow, which is good. But the implications are more complicated and even a Federal Reserve rate hike stop won’t keep actual short-term interest rates from continuing to climb.

The Consumer Price Index for All Urban Consumers (CPI-U) was up 0.1% from April to May on a seasonally adjusted basis. That is significantly less than the 0.4% increase between March and April. On a non-seasonally adjusted basis, that is just over 4% year-over-year, the lowest annual jump since the 2.6% of March 2021.

So far, so good. Further into the details, though, is where things get hazier.

“The May CPI readings came in right in line with expectations, with the headline rising just 0.1% on the month, but a faster increase of 0.4% at the core level,” Nationwide Chief Economist Kathy Bostjancic wrote in an email note.

As LPL Financial Chief Economist Jeffrey Roach wrote, “The largest contributor to the monthly increase in prices were shelter costs.” Also providing upward pressure were transportation and used vehicles. Food remains

Energy prices was the largest drag, falling 3.6% in May. Prices at restaurants are still rising at a fast clip, indicating that consumer demand is still strong for restaurant service. The overall theme in recent months has been strong consumer demand for experiences over stuff and we are seeing that play out in consumer pricing dynamics.”

While consumer demand remains high — and there’s enough money in their pockets to spend — that raises the possibility of inflation not falling as quickly as the Fed wants to see. Even now, a 4% year-over-year rate is far above the target 2%.

“Overall, the data set should provide cover for the Fed to take a pause at tomorrow’s meeting, but the sixth consecutive month of increases above 0.4% in core inflation questions the need for more rate hikes and leaves the option open for another hike at the July meeting,” writes Charlie Ripley, senior investment strategist at Allianz Investment Management. “On the other hand, adding another 25 to 50 basis points of rate hikes is not likely to change the trajectory of inflation after the Fed has already implemented 500 basis points of tightening and perhaps the best ammunition for the Fed to fight inflation currently is time.”

Unfortunately, even if the Fed lays off in June, short-term interest rates will continue to climb because of the aftereffects of the late debt ceiling resolution. The higher shorter-term Treasury yields rise, the higher market rates must increase to account for the safe alternative investment. A 26-week Treasury that issued on March 30, 2023, went on initial sale for an annual percentage return of 4.83%. But a 26-week Treasury bill that will issue June 15 auctioned with an investment rate of 5.38%, a 55-basis point jump. While CRE rates may eventually halt their growth and even fall, today is not that day.