Tonight's CPI is a "mixed bag": Overall inflation may surpass 4% to hit a three-year high, while core inflation may be significantly lower than expected!
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At 20:30 Beijing time tonight, the US Bureau of Labor Statistics will announce the May CPI data. This is also the most closely watched key inflation data in the market ahead of the Federal Reserve's new chairman Waller's policy rate meeting next week.
According to Wind Trading Desk, Wall Street's four major institutions—Goldman Sachs, UBS, Deutsche Bank, and Morgan Stanley—intensively released forward-looking reports ahead of the data release. The forecasts from these four institutions vary in numbers but are similar in direction: overall inflation may be high, but core inflation may not be as hot. Energy prices push up the overall CPI, while factors such as rent and car insurance lower the core CPI.
Overall CPI may rise above 4% to a three-year high, core CPI may be below consensus
The forecasts show that the four institutions’ predictions for the year-on-year overall CPI in May are concentrated in the 4.17%-4.3% range, all higher than April’s 3.81%. However, core CPI month-on-month predictions are generally lower than market consensus.
There is an obvious divergence between the trends of overall inflation and core inflation.
The “worry” is overall inflation. The year-on-year forecasts from Goldman Sachs, UBS, Deutsche Bank, and Morgan Stanley are all above 4%. Deutsche Bank’s estimate of 4.27% and Morgan Stanley’s 4.3% are 46-49 basis points higher than April and will be the highest since April 2023.
The “better” part is core inflation. Excluding food and energy, the month-on-month core CPI may only be 0.17%-0.22%, significantly lower than the mainstream market expectation of 0.27%-0.30%.
Overall inflation may break through 4%: energy is the “culprit”
Energy will be the main driving force behind the possible jump in inflation this time.
After the outbreak of war in Iran, US retail gasoline prices soared, pushing energy commodity prices up by about 6%–7% month-on-month in May, and the entire energy category’s monthly increase was close to 4%. This effect directly pushed the year-on-year overall CPI from April’s 3.81% to May’s 4.17%–4.3%.
Deutsche Bank’s estimate shows that energy inflation year-on-year may approach 24%, whereas it was only 0.5% in February.
Airfare increases are one of the most direct transmission chains. Rising fuel costs directly push up airline operating costs, and May airfare prices are expected to rise 1.3%–2% month-on-month.
The good news is that gasoline prices dropped by about 40 cents per gallon since peaking on May 20. UBS expects this will result in the June overall CPI falling by about 0.13% month-on-month, with the year-on-year dropping to around 3.81%. In other words, May is likely the peak of this round of overall inflation.
Why is core inflation lower than expected? The key is cooling housing
Core CPI excludes food and energy. Because these two hottest categories are excluded, the May core data will look much milder.
In US CPI, housing has a high weighting, about 35%.
Goldman Sachs and UBS both predict that owner’s equivalent rent (OER) and primary residence rent in May will rise about 0.22%–0.23% month-on-month, continuing the slowdown trend. In April, these two categories rose 0.53% and 0.55% month-on-month respectively. Deutsche Bank also lists “housing inflation trends remaining mild” as a reason for the softness in core inflation.
Due to the high weighting of OER, even just a drop from around 0.5% to just over 0.2% will significantly lower the core CPI reading.
Car insurance is also a cooling point.
Goldman Sachs expects car insurance prices to fall 0.1% month-on-month in May. Its online data model shows premium changes signal a downward trend for car insurance CPI. Deutsche Bank also mentions that car insurance is expected to be weak again.
Used cars also do not have obvious upward pressure. Goldman Sachs expects used car prices to be flat, and new cars to rise 0.1%. UBS expects used car prices to drop 0.26%, and new cars to drop 0.10%.
This means that the few items that have frequently disturbed US core inflation in recent years—housing, car insurance, and used cars—have not given strong inflation signals this time. In other words, the low core CPI in May is not just a “sudden cooling” in a single category.
Core inflation is not cooling across the board: airfares, IT goods, and some services remain under pressure
Core CPI below consensus does not mean all core sectors are cooling.
Airfare is an upward item.
Goldman Sachs expects airfare prices to rise 2% in May. UBS expects a rise of 1.34%. The reason is that aviation fuel prices remained high for most of May and may be passed on to ticket prices.
There are large disagreements over hotel price forecasts. Goldman Sachs expects hotels to rise 0.2%; UBS, based on Smith Travel Research data, lowers accommodation forecasts and expects out-of-home prices to fall 0.77%. But UBS also notes that CPI counts price at reservation, while STR data is more about price at check-in, and timing differences may cause upside risk, especially as demand for the World Cup may appear early.
Goods also show stickiness.
UBS expects core goods prices to rise 0.08% month-on-month, between March’s 0.11% and April’s 0.03%. Their judgment is that tariffs’ impact on 12-month core goods inflation may have just passed its peak, but residual transmission will keep monthly core goods prices growing slightly for the rest of the year.
Deutsche Bank also points out that import prices show IT goods maintain strong momentum, including global memory chip prices staying high. At the same time, clothing PPI shows clothing inflation remains strong, but import prices are weak, and CPI momentum may slow compared to previous months.
Services are more complicated.
UBS raised its forecast for non-rent core services prices from 0.17% to 0.21%, because the S&P Global US consumer services output price diffusion index shows that the proportion of consumer services companies raising prices in May increased, reaching the second highest level since 2009 outside the pandemic anomalies.
What really matters tonight is not just overall inflation above 4%
The headline number for May CPI may be high, but dissected details are more critical.
If overall CPI is high, mainly due to gasoline and energy, the market may look at the decline in June gasoline prices to judge the sustainability.
If core CPI is significantly lower than expected, the market will further explore the source of low inflation: is it due to slowing housing trends or just a one-off seasonal drag?
If airfares, IT goods, and non-rent services remain strong, the “quality” of core cooling will be discounted.
So this CPI may give the market two messages:
On one hand, overall inflation is breaking 4% again, possibly hitting a new high since April 2023.
On the other hand, core inflation may only be around 0.2%, noticeably below market consensus.
This is what makes tonight’s CPI most difficult to trade: overall inflation looks hot, core inflation may not be so, oil prices push up the overall, housing and car insurance pull down the core.
Inflation swap pricing: The market is betting on a dollar surprise rally
Currently, the rate swap market prices May overall CPI at 4.27%–4.28%, slightly higher than Bloomberg’s survey median of 4.2%.
Morgan Stanley strategist Molly Nickolin’s analysis framework shows that inflation swap pricing has accurately predicted the direction of year-on-year inflation in 9 out of the past 12 CPI releases. Current pricing, compared to economist expectations, implies an upside surprise of about 0.48 standard deviation.
Based on historical backtesting, a 0.48 standard deviation upside surprise typically corresponds to the DXY Dollar Index rising about 0.14% within 1 hour after the announcement. Among all G10 currencies, the Swedish Krona (SEK) performs the worst on “bullish dollar” CPI days, with the biggest average drop.
Looking ahead: oil prices are the biggest variable in the inflation path
The trajectory of core CPI in the coming months depends on how long oil prices stay up.
The current benchmark forecast: month-on-month core CPI stays at around 0.2%. But if the Middle East situation persists and oil prices do not fall as expected, the upside risk will be more prominent—not only will high oil prices directly push up energy prices, they will also permeate core inflation through airfares, transportation, and other intermediate links.
Deutsche Bank’s long-term forecast is more pessimistic: even if oil prices start to fall in June, overall energy inflation year-on-year will remain above 10% until early 2027, then turn negative. Core services inflation (excluding rent/OER) is also expected to stay above 3% for a long time.
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