As we approach the release of the May Consumer Price Index (CPI), investment bank UBS has presented a scenario that could reshape the inflation narrative.
UBS forecasts a monthly increase of just +0.17% for core CPI, which excludes volatile food and energy prices. This is significantly below the market consensus of +0.3%. If this number holds, it would translate to an annualized rate of about 2.06%, bringing inflation remarkably close to the Federal Reserve's 2% target. This is particularly significant as it comes during the 'FOMC blackout period,' a time when Fed officials refrain from public comment, making the market highly sensitive to economic data.
So, what's behind this optimistic forecast for core inflation? First, there are signs of cooling pressure. The New York Fed's recent survey shows that consumers' inflation expectations are stable, which helps prevent a wage-price spiral. Second, the labor market is moderating. Recent job reports indicate steady but not overheating growth, which limits upward pressure on wages and, consequently, service prices. Finally, weak sentiment among small businesses suggests they have less power to pass on higher costs to consumers.
However, the story for headline CPI, which includes all items, is different. UBS expects a higher monthly increase of +0.46%, driven primarily by a surge in gasoline prices that peaked in mid-May. But there's a silver lining here, too. Gasoline prices have already started to fall in early June, suggesting this spike in headline inflation might be temporary. This supports the idea that we may have seen the 'peak' for energy-driven inflation.
Of course, there are countervailing factors to consider. Used car prices, a key component of core goods, saw a slight rebound in May, which could limit the extent of disinflation. Additionally, the Fed's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, is still expected to run hotter than the CPI. Should the UBS forecast prove accurate, the Fed would likely hold interest rates steady in June but could pave the way for a highly anticipated rate cut in September.
- Core CPI: An inflation measure that excludes volatile items like food and energy prices. It is often seen as a better indicator of underlying long-term inflation trends.
- FOMC Blackout Period: The period before a Federal Open Market Committee (FOMC) meeting during which Federal Reserve officials are prohibited from speaking publicly about monetary policy.
- Annualized Rate: A rate of return for a period shorter than one year, but computed as if the rate were earned over a full year.