US Week Ahead: Inflation likely to hit a three-year high in May
At a Glance
The desk anticipates that the upcoming inflation data will reinforce concerns about persistent price pressures in the U.S., as RBC forecasts a headline inflation increase of +0.5% m/m in May, leading to an annualized inflation rate of 4.2%. This continues to be driven largely by higher energy costs, with core inflation expected to rise as well, albeit at a slower rate of +0.3% m/m to 2.9%. Per the full note by RBC Economics, this scenario poses challenges for the Federal Reserve, which seeks to manage inflation expectations without derailing economic growth, especially given the labor market's robust performance in recent reports. As traders prepare for potential volatility in response to these figures, they should closely monitor the implications for policy direction and currency valuations.
Key Takeaways
- 01RBC forecasts May headline CPI to increase by +0.5% m/m, resulting in a year-over-year rate of 4.2%.
- 02Core inflation is expected to rise by +0.3% m/m to 2.9%, well below headline rates but concerning for Fed policy.
- 03Strong job creation (172K) highlights potential resilience in the economy, yet maintaining inflation control may require Fed action.
- 04Manufacturers retain pricing power, as shown by +0.6% m/m projected rise in PPI for both headline and core.
Full Analysis
What the desk is arguing
The upcoming inflation data is expected to highlight continued pressure on prices, with RBC projecting a headline CPI increase of +0.5% m/m for May. This aligns with a broader trend of climbing prices, driven by energy and food sectors, which are forecasted to keep inflation elevated throughout the summer months. The desk frames this as a potential catalyst for further Fed tightening if inflationary trends persist and labor market strength continues, suggesting traders remain vigilant regarding Fed policy shifts.
RBC notes that Johnson manufacturers and service firms are passing on input costs, indicated by a +0.6% m/m increase in both headline and core PPI for May, raising prices to a 6.3% y/y growth for headline and 5.5% for core. This suggests that businesses feel emboldened to set higher prices due to sustained demand, compelling the Fed to consider tighter monetary policy to combat inflation as unemployment continues to hold relatively low at around 172K new jobs.
In contrast to bearish indicators, strong job growth may provide a cushion against severe economic contraction, contradicting fears of widespread layoffs, thereby supporting consumer spending. The alternative read would be that if inflation starts to cool alongside easing energy prices, the Fed may adopt a more dovish stance posturing less aggressive rate hikes this year, an outlook that seems less likely given the robust inflation predictions from RBC.
Market Implications
Traders should focus on the potential impacts of rising inflation rates on Fed policy sentiment, especially if CPI prints align with RBC's forecast. Watch for significant currency movements around the release of inflation data to gauge market sentiment regarding interest rate adjustments. A sustained uptick in inflation may bolster USD strength against peers.
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The desk interprets the recent uptick in US inflation data as a signal that the Federal Reserve remains firmly on the sidelines, despite rising price pressures. Per the full note from CIBC, the April CPI rose to 3.8% year-on-year, slightly above the 3.7% consensus, driven by higher energy and shelter costs. This inflationary pressure is not expected to prompt an immediate Fed response, as market expectations currently align with no rate changes until year-end. The desk emphasizes that the Fed is likely to remain inactive until inflation trends closer to its 2% target or unemployment rises significantly, which aligns with CIBC's forecast.