The consumer price index was hotter than expected in May, as CPI inflation overshadowed its 40-year peak in March. After the stock market crash on Thursday, the Dow Jones fell sharply after the CPI report, which shifted Wall Street’s expectations of raising the Fed’s interest rates by half a point in the next three or even four meetings.
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The CPI increased by 1% compared to the previous month and by 8.6% from a year ago, compared to inflation of 8.3% in April and 8.5% in March. The core CPI, which eliminates volatile food and energy categories, rose 0.6% from April. However, annual core inflation fell to 6% from 6.2% in the previous month. Core inflation of 6.5% in March was the highest since August 1982.
Economists expected the overall CPI to rise by 0.7% for the month as annual CPI inflation fell to 8.2%. The core CPI is up 0.5% from April and 5.9% from a year ago.
Inflation in non-energy services, which affects 57% of consumer budgets, rose 5.2% from a year earlier, surpassing the 30-year high of 5.1%.
Commodity prices, excluding food and energy, rose 0.7% for the month, bringing annual inflation to 8.5% from 9.7% in April.
Economists expected commodity prices to fall. However, significant cooling of service inflation will be needed for the Federal Reserve to adjust policy.
The monthly growth of 0.6% of the core consumer price index, if maintained, would lead to 7.2% annual core inflation rate. This compares to the Federal Reserve’s 4.1% forecast for core inflation in 2022. If inflation continues to exceed the Fed’s projected levels, politicians are likely to have to tighten further and faster than expected.
Note that the CPI differs from the Federal Reserve’s preferred cost index for personal consumption. The latter includes government purchases on behalf of consumers, such as Medicare and Medicaid. It also affects the substitution effect when high prices force consumers to adapt their buying behavior.
Dow Jones, Treasury Yields Response to CPI inflation
The Dow Jones Industrial Average fell 2.4% at the beginning of the stock market on Friday. The S&P 500 sank 2.6 percent and the Nasdaq composite sank 3.1 percent.
It remains to be seen whether inflation, which is beginning to decline from its peak, can create a sustainable rally. Be sure to read IBD’s Big Picture column after each trading day to get the latest stock market trends and what this means for your trading decisions.
Markets have been pulling the strings lately, with softer economic data boosting hopes for an upcoming change in Fed policy. However, reports from the Federal Reserve, including Chief Jerome Powell’s warning of impending “pain,” suggest there is no delay in tightening the Fed. CPI data on Friday certainly added weight to the bear case.
The Federal Reserve is expected to raise interest rates by 50 basis points at next month’s policy meeting. Another half-point increase is expected in July. However, following the CPI report, FedEatch’s CME Group page shows huge chances of further increases of at least 50 basis points in the June, July and September meetings, with slightly better than even half-point increases in November. This will lead to the target range of federal funds to 2.75% -3%, compared to 0.75% -1% at present.
Towards Thursday’s close, the Dow fell 12.3% from its record high on January 4. The S&P 500 fell 16.2% from its peak, while the Nasdaq fell 26.8%.
After the CPI report, the yield on 10-year bonds rose by 7 basis points to 3.10%. The two-year yield jumped 14 basis points to 2.96%.
Details of the CPI inflation report
The prices of used cars and trucks jumped by 1.8% compared to the month and increased by 16.1% compared to the previous year. However, this compares with the annual profit of 35.3% in March.
Demand for used cars has risen amid a global shortage of chips that has halted production of new cars. The prices of new vehicles increased by 1% compared to the month, while they increased by 12.6% compared to the previous year. The annual increase of 13.2% in April was the largest annual increase since 1949.
Energy prices increased by 3.9% compared to the month and increased by 34.6% compared to the previous year. Gasoline prices have set new highs in recent days.
Out-of-home food prices rose 0.7% in May from April, while they rose 7.4% from last year. The prices of food consumed at home rose by 1.4% last month and by 11.9% a year ago.
The prices of medical services increased by 0.4% compared to the month, which led to 4% on an annual basis.
Meanwhile, shelter prices rose 0.6% in May, with owners’ equivalent rents rising 0.6%.
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