May CPI preview: Incremental improvement

Summary

April marked a step forward in getting inflation back on a downward path after price growth picked up in Q1. Yet the FOMC will need to see inflation downshift further in order to gain the "greater confidence" needed to eventually reduce the fed funds rate. May's CPI report is unlikely to suggest inflation is rapidly approaching the Fed's target, but it should at least offer more evidence that the first quarter's flare-up has subsided.

We estimate headline CPI rose 0.1% in May, which would mark the smallest monthly gain since last October thanks in part to an unusual drop in gasoline prices for this time of year. Excluding food and energy, the CPI likely advanced 0.3% again in May, with the drivers little different from April. Core goods prices likely fell another tenth or two amid the ongoing slide in vehicle prices and a modest decline in other core goods. Prices for core services look to have increased 0.4% for a second straight month amid the slow moderation in housing and other services inflation.

Another 0.3% monthly increase in core CPI would nudge the year-over-year rate down to a three-year low of 3.5% and point to core PCE inflation edging down to 2.7% in May. Inflation as measured on a year-ago basis likely will hold at these rates through year-end amid unfavorable base effects. That said, we continue to look for monthly readings to gradually trend lower as inflation pressures subside. The slow pace of improvement may not be enough to convince some Fed officials over the next few months that inflation is headed back to target on a sustained basis.

May CPI: Inflation likely no worse but not meaningfully better than April

April marked a step in the right direction for getting inflation back on a downward path. After surprising to the upside for three consecutive months with 0.4% gains, core CPI rose 0.3% to match consensus expectations. Core PCE inflation also eased up a little, with April's 0.25% rise smaller than the 0.36% monthly average in the first quarter. While April delivered more palatable inflation readings relative to the first three months of the year, core CPI and core PCE nonetheless rose at one-month annualized rates of 3.6% and 3.0%, respectively. Thus, we see a need for even softer inflation readings over the next few months to keep prospects of a Fed rate cut this year alive without a marked weakening in the labor market.

May's CPI report is unlikely to suggest inflation is rapidly approaching the Fed's target, but it should at least offer more evidence that the first quarter's flare-up has subsided. We estimate headline CPI rose 0.1% in May, which would mark the smallest monthly gain since October. Meantime, core CPI likely advanced 0.3% again in May, which would nudge the year-over-year rate down to a three-year low of 3.5%.

Download The Full Special Commentary