The May CPI Report Could Deliver Another Hot Surprise

sbayram/iStock via Getty Images The CPI report is expected to show some cooling on the headline for May, with an expected increase of just 0.1% m/m, down from 0.3%, while rising by 3.4% y/y in line with last April. Core CPI is another story. It is expected to remain on trend, as in April at 0.3% while rising by 3.5% y/y, down from 3.6% in April. CPI swaps agree with analysts’ estimates, with the headline rising by 0.1% m/m and 3.4% y/y. Meanwhile, Kalshi, the Cleveland Fed, and Bloomberg Economics also project a 3.4% increase y/y. So, there aren’t many divergences among expectations this month. Recent trends suggest that the headline estimates could prove to be too low. Bloomberg Wage Growth Suggests 4% Inflation Despite these estimates, there isn’t much to suggest that overall inflation has changed since April, except for slightly lower gasoline prices. The wage growth numbers in the May job report indicate an inflation rate still around 4%. Meanwhile, the May job data showed that wages grew by 4.1% y/y, hotter than last month’s upwardly revised 4.0% from the previously reported 3.9%. Wage growth seems, like inflation, to have stalled around this 4.0% region. Maybe it will resume its path lower at some point later this year, but at this point, we are not seeing that slowing. Bloomberg A 4.1% wage growth rate is inconsistent with a 2% inflation rate, or anywhere close to it. Based on these readings, we need higher productivity levels to bring inflation down to the Fed’s target. Productivity in the first quarter was just 0.2%. Over the last 14 quarters, the productivity index has risen only 0.62%, an annualized growth rate of just 0.2%. Bloomberg So, 4% wage growth and near 0% productivity are consistent with the roughly 4% core CPI inflation rate over the last 19 months. There is much more evidence to support a core inflation rate that has been stuck around 4% in recent months than evidence to suggest that the Fed is winning the battle against inflation. If the core CPI comes in as expected in May, it will be on trend for the 20th month at 4%. Bloomberg Core CPI To Bottom In May The problem is that based on the current trend over the past 19 months, and potentially, once again, confirmed in May, the y/y core CPI rate will increase to 3.7% in June, then 3.8% in July, and 3.9% by August at its current pace. So, the core CPI report y/y reading in May will be the low, followed by a turn higher. Bloomberg Meanwhile, the slower rise in the headline CPI will likely be driven by lower oil and gasoline prices in May. The rise of 0.1% is certainly not within the trend we have seen in recent months. Over the past 20 months, headline CPI has risen at an annualized rate of 3.6%. Based on analysts’ estimates, it would also be the lowest monthly headline increase since October month-over-month and a clear shift in the trend. Bloomberg However, the most significant thing here is if services and shelter inflation come in at a pace that allows the May reading to fall below the trend rate of the past 20 months. Shelter inflation has slowed down, and services inflation has been anything but cooperative. CPI core services, less housing, has been trending higher since June 2023 and rose by almost 5.2% year over year in April, and trending higher. Bloomberg The problem is that there has been a notable shift in the trend of core services. The annualized growth rate for the first four months of 2024 is noticeably faster than the growth rate for the first four months of 2023, rising by 7.46% versus 4.64%, respectively. Bloomberg Meanwhile, based on the Case-Shiller Indexes, CPI owners’ equivalent rent has come down slowly but has tended to trail housing prices by around 18 months. Those Case-Shiller values have turned higher in recent months. Whether that leads to housing prices, as measured by the OER, turning higher over the next few months will tell whether or not the inflation battle will be won. Bloomberg Additionally, shipping rates continue to surge, with the WCI container benchmark increasing since the beginning of the year. More notably, they have surged even more in recent weeks. So, while energy prices may be down some in May, and autos may also weigh on inflation, it may not be as easy to attain that 0.1% as analysts estimate. Bloomberg Money Is Moving Much Faster But in the end, the fundamental problem appears to be that money growth has stalled out, with M2 Money Supply and Bank Deposit shrinking in recent years, while nominal GDP has accelerated, creating an upward movement in money velocity, no matter how it is measured. A rising velocity of money tells us that $1 today is racing through the economy much faster, and that is inflation. Rising bond yields, which tend to track and move with money velocity, also demonstrate this. This tells us that bond yields will likely continue to rise until nominal growth slows, money supply growth accelerates, and velocity turns lower. Bloomberg The latest data from the job report also shows that nominal growth hasn’t likely slowed as measured by the Index of Aggregate Weekly Payrolls, which tends to track nominal GDP over time. At least through May, that number was pretty flat with April’s and still faster than January’s. Bloomberg Meanwhile, the latest bank deposit data suggest that growth in M2 has not likely changed much in recent weeks. At this point, money growth remains fairly stagnant, which suggests that dollars are still running through this overall economy at a high rate. Bloomberg So, while this month’s CPI report could come in at a much more desirable pace on the headline, this also seems to be a month where expectations are very low and driven by lower energy and autos. This may not offset some other factors witnessed in recent months in core services, coupled with stubborn housing costs and rising shipping costs. However, it would seem that if this is one of those months, it could catch the market off guard. In the end, fundamentals in the economy tell us that overall, the inflation rate is between 3.5% and 4%, and there is little evidence to suggest that it is changing.

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