What To Expect From May’s CPI Report

Inflation is coming down, but not as fast as the Federal Reserve wants. On May 10 at 8.30am ET, we’ll receive an update on the Consumer Price Index for the month of April.

Nowcasts

Inflation nowcasts from the Cleveland Fed suggest a 0.5% month-on-month increase in core CPI for April, perhaps driven in part by rising energy costs during the month. That would disappoint the Fed, as it would hold annual inflation at over 5%.

However, after this upcoming CPI reading, things may improve on the most recent nowcast analysis. May’s monthly increase is forecast at 0.3%, and that, compared with sharply rising prices from May 2022 falling out of the series could finally bring annual CPI below 5% for the first time since 2021.

In addition, high month-on-month inflation from June 2022 rolling out of the 12-month series the following month, may enable that month’s inflation reading may trend lower still.

However, the question remains as to when and if inflation will return to the Fed’s 2% target, and when the Fed may consider inflation sufficiently close to target levels that it is willing to ease back on interest rates. For now, the Fed appears set to hold rates at high levels for the remainder of 2023, based in part on the belief that inflation will remain stubbornly high. Though the bond markets aren’t convinced that the Fed will stay the course.

Home Prices

The key thing to look at within the CPI data will be shelter costs, basically the CPI’s term for housing costs. The CPI reports have had shelter costs rising at over 8% year-on-year recently, but industry data from Redfin
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suggests that median U.S. home prices may be falling year on year. The reason for the disconnect is that the CPI uses a series of panels to calculate housing costs, which can add a lag to the data of at least 6 months at turning points in the cycle, just as we may be seeing now.

Shelter costs make up a majority of the CPI’s importance weighting in calculating U.S. price trends, so if shelter costs start to move down, that could well bring down the overall inflation reading. So far we haven’t seen that, but it may be getting close. Should that happen it may create a path for inflation to return to the Fed’s 2% target and potentially enable the Fed to reconsider the path for interest rates.

Fed Reaction

The Fed meets again on June 13-14 so we’ll have another CPI release and other crucial economic data before then. As such the upcoming CPI inflation reading will be important, but is unlikely to be decisive for the Fed’s thinking leading into the next rate decision.

Market Expectations

Currently markets expect the Fed to hold rates steady at that June meeting with a small chance the Fed elects to make another small hike in interest rates. That would likely only occur if inflation came in well above expectations.

Still the markets believe there’s a good chance that the Fed will be cutting rates by September and maybe even July. In order for that to happen we would likely need to see more data in upcoming releases that inflation is trending significantly lower, or some weakening of the U.S. economy, perhaps through the jobs market.

The upcoming CPI release may continue to reinforce the narrative that inflation is not falling as fast as many would hope. However, even if that’s the case there’s a chance that subsequent readings are more encouraging, either due to price hikes from 2022 falling out of the 12-month series or home prices easing in the CPI’s data set. Either way there’s lot of important economic data to come before the Fed meets again on June 13-14.