US CPI Inflation Rate Hits Lowest in Over 2 Years... Fed's 'Hawkish Pause' Confirmed (Comprehensive)

Ahead of the U.S. Federal Reserve's (Fed) decision on the benchmark interest rate, the consumer price inflation rate has dropped to its lowest level in over two years. Having raised rates consecutively for 10 times since March last year, the Fed is widely expected to adopt a 'hawkish skip' this week as anticipated. However, with service prices such as housing costs remaining sticky and the labor market still overheated, the Fed's deliberations over the pace of future tightening are expected to continue.

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U.S. CPI Rises 4%, Matching Expectations... Lowest in 2 Years and 2 Months

According to the U.S. Department of Labor on the 13th (local time), the Consumer Price Index (CPI) for May rose 4.0% compared to the same month last year. This figure aligns with expert forecasts compiled by The Wall Street Journal (WSJ) and Dow Jones. Not only is this lower than the 4.9% increase in April, but it also marks the smallest rise in 2 years and 2 months since March 2021. The May CPI also rose only 0.1% month-over-month, confirming a slowdown in inflationary pressures. The core CPI, which excludes volatile energy and food prices, also rose 5.3% year-over-year and 0.4% month-over-month, matching expectations.

U.S. President Joe Biden called it "good news" in a statement shortly after, saying it "shows continued progress in tackling inflation while maintaining historically low unemployment." He emphasized, "Annual inflation is at its lowest level since March 2021 and less than half of what it was in June last year," adding that "inflation has declined for 11 consecutive months."

By item, energy prices showed a notable decline. Energy prices fell 3.6% over the month. During the same period, fuel oil and gasoline prices dropped 7.7% and 5.6% respectively compared to the previous month. Airfares (-3.0%), meat (-1.2%), and dairy products (-1.1%) prices also decreased. Analysts suggest that the easing of 'revenge spending' following the pandemic has led to a moderation in airfares and hotel accommodation prices, signaling signs of inflation easing. On the other hand, service prices including housing costs remain major contributors to inflation. Housing costs rose 0.6% month-over-month, increasing from the 0.4% rise in the previous month. Year-over-year, housing costs increased by 8.0%. Transportation services jumped 10.2% year-over-year and 0.8% month-over-month. Prices for used cars and trucks, which had been declining earlier this year, surged 4.4%.

The CPI inflation rate easing to its lowest level in 2 years and 2 months is interpreted as a signal that the Fed's monetary tightening efforts over the past year have been effective. Omar Sharif, President of Inflation Insights LLC, said in an investor memo, "This is quite a good sign as the core CPI could also weaken substantially starting next month." Laura Rosner-Warburton, Chief Economist at Macropolicy Perspectives, noted, "Fed officials are likely feeling some relief with the CPI meeting expectations," diagnosing that the CPI report contains both encouraging and disappointing news.

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Fed Likely to Hold Rates Tomorrow... FedWatch Shows 96% Probability of Pause

Market expectations that the Fed will announce a rate hold decision the following day have strengthened. According to the Chicago Mercantile Exchange (CME) FedWatch tool, the federal funds (FF) futures market reflected about a 96% probability of a rate hold in June as of that morning. This is a significant increase from around 79% the previous month, making a hold almost certain. Conversely, the chance of a 0.25 percentage point hike dropped to around 4%.

Shima Shah, Global Chief Strategist at Principal Asset Management, said, "For the Fed to raise rates in June, there would have needed to be a meaningful surprise rebound in inflation," adding, "With the CPI meeting expectations, that pressure has disappeared." Bill Adams, Chief Economist at Comerica Bank, predicted, "The Fed will hold off on a rate hike tomorrow."

Recently, both inside and outside Wall Street, the scenario that the Fed will skip this month's rate decision and signal a July hike, known as a 'hawkish skip,' has been considered the most likely. After raising the benchmark rate to 5-5.25% through 10 consecutive hikes, the Fed hinted at an imminent pause by removing the phrase 'additional policy firming is appropriate' from the monetary policy statement at the May FOMC meeting.

The New York Federal Reserve's one-year inflation expectations rate (4.1%) released the day before also fell to its lowest level in about two years, supporting this view. Officials' remarks about pausing hikes to assess the cumulative tightening effects and economic conditions were followed by inflation data. After the CPI release, the Producer Price Index (PPI) for May, a wholesale price indicator, will be published the next morning.

Gargi Chaudhuri, Head of Investment Strategy America at iShares, told CNBC, "The Fed will likely go for a 'skip' rather than a 'pause' to observe the cumulative tightening effects," supporting the hawkish skip outlook. "By signaling at least one more hike by the end of 2023, they aim to keep maximum options open." Anna Wong, Economist at Bloomberg Economics, said, "May's CPI gives the Fed room to skip a hike in June."

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Inflationary Pressures Persist... "Risk of Monetary Policy Mistakes Has Increased" Diagnosed

However, concerns about persistent inflationary pressures continue. Experts emphasize that the Fed's tightening is not over, citing still-high core CPI and an overheated labor market.

Brian Coulton, Chief Economist at Fitch, warned, "Don't be fooled by the sharp drop in headline CPI explained by falling gasoline prices," pointing out, "Core CPI still shows stubbornly high inflationary pressures." He predicted, "Rising commodity prices and continued rent increases will not reassure the Fed." Mark Zanni, former New York Fed official and current Chief Economist at Barclays, said, "The Fed has a lot to do." Economist Anna Wong, who forecast a hold this month, noted, "The slow progress in core CPI highlights how unlikely it is that the Fed will cut rates this year."

Accordingly, Fed Chair Jerome Powell is expected to signal a strong hawkish tone, indicating that even if rates are held tomorrow, a hike could come as soon as July. The current rate futures market reflects over a 60% probability of a 0.25 percentage point hike next month following this month's hold. Previously, the central banks of Australia and Canada surprised markets by raising rates despite expectations of a hold.

This situation suggests that monetary policy decisions have become increasingly challenging. Jeremy Stein, a former Fed official, warned WSJ, "It has become harder to understand what is happening in the economy in real time, making mistakes more likely," adding, "The risk of monetary policy errors has increased." William English, a professor at Yale School of Management, supported further hikes, saying, "If you are confident you will raise rates at the next meeting, you should do it now."

Investors' attention is focused on Chair Powell's press conference, the dot plot, and revised economic forecasts the following afternoon. These will be used to gauge the future direction of monetary policy. In particular, how much the year-end rate forecast in the dot plot is raised compared to previous projections is key, as the upward adjustment essentially signals additional rate hikes. In March, the Fed's dot plot showed a median year-end rate forecast of 5.1%, and U.S. rates have already reached that level.

Meanwhile, the New York stock market is rallying on relief as expectations for a rate hold strengthen. The Dow Jones Industrial Average, composed of blue-chip stocks on the New York Stock Exchange (NYSE), is trading about 0.57% higher than the previous close. The S&P 500, focused on large-cap stocks, and the tech-heavy Nasdaq Composite are also recording gains of around 0.6% each. The Volatility Index (VIX), known as Wall Street's fear gauge, has fallen to around 14.65, below its long-term average of 20.

This content was produced with the assistance of AI translation services.