Driven by the ongoing conflict in the Middle East, which has pushed up energy prices, U.S. consumer inflation is expected to climb to its highest level in nearly three years in May. This trend will not only further squeeze the real purchasing power of American households but also provide new policy justification for the Federal Reserve to keep interest rates unchanged for the remainder of the year. The upcoming Consumer Price Index report from the U.S. Department of Labor indicates that inflation in May may show a strong year-on-year increase for the third consecutive month, highlighting the growing pressure on ordinary households in terms of daily expenses. Notably, the inflation rate in May is expected to outpace wage growth for the second consecutive month, meaning that Americans' real income is shrinking, which could drag down overall economic growth.

Key data forecast: Year-on-year growth rate hits new high since 2023

According to a survey of several economists, the U.S. Consumer Price Index (CPI) is projected to rise 4.2% year-over-year in the 12 months ending in May. This would be the largest annual increase since April 2023, following a 3.8% increase in April and a 3.3% increase in March. On a month-over-month basis, the CPI is expected to rise 0.5% in May, a slight decrease from the 0.6% increase in April.

It should be noted that the Federal Reserve actually uses the Personal Consumption Expenditures (PCE) price index as the benchmark for its 2% inflation target, but currently all inflation indicators, including the CPI and PCE, are well above the Fed's target level.

The core drivers of rising oil prices: geopolitical conflicts and energy market volatility

The surge in gasoline prices was the most direct factor driving up inflation in May. According to data from the U.S. Energy Information Administration, the average gasoline price across the country rose 8.8% in May, reaching $4.60 per gallon. Since the U.S.-Israel military strikes against Iran in late February, gasoline prices had previously surged by more than 50%.

Although international oil prices have recently fallen following the ceasefire agreement, leading some economists to be cautiously optimistic that May may mark a temporary peak in the current CPI increase, the situation in the Middle East remains highly uncertain.

Stanley, chief U.S. economist at Santander's U.S. Capital Markets division, pointed out that overall inflation is likely to peak year-over-year in May, but if the situation in the Middle East deteriorates again, oil prices could surge, pushing up inflation. Furthermore, while disruptions to shipping in the Strait of Hormuz have increased fertilizer prices, this has not yet significantly translated into higher food prices.

Political and Economic Impacts: The Trump Administration's Governing Burden

The soaring cost of living is undoubtedly a heavy political burden for incumbent President Trump and his Republican Party. Trump's victory in the 2024 presidential election largely depended on his promises to reduce inflation and improve people's livelihoods. However, his approval ratings have declined significantly as public disappointment with his handling of economic issues grows.

Currently, the Republican Party is trying to maintain control of Congress in the November midterm elections, and the high inflation environment may be a key factor influencing voters' intentions.

RSM chief economist Brusuelas said that overall inflation will outpace wage growth for the second consecutive month, meaning that Americans’ real income is decreasing. If this trend continues, it often foreshadows serious challenges for household consumption in the second half of the year.

Core inflation and structural factors: The one-off shock to rents has subsided, and the service sector has not yet been significantly affected.

After excluding the more volatile food and energy components, the performance of core CPI in May is also worth noting. The year-on-year increase in core CPI in May is expected to be 2.9%, higher than April's 2.8%; the month-on-month increase is expected to be 0.3%, a slowdown from April's 0.4% increase.

The expected slowdown in core CPI monthly growth is partly due to data collection disruptions during last year's government shutdown, and the waning effect of a one-off adjustment to the rent indicator. While the surge in spending on artificial intelligence is driving up prices for computers and software, these goods have a relatively small weighting in the core CPI calculation basket.

Furthermore, the unexpected drop in used car and truck prices has also somewhat curbed commodity inflation. It is worth noting that, apart from high airfares, there are currently no clear signs that the impact of rising oil prices has widely spread to the service sector.

Tariff Controversy and Labor Market Resilience

Economists hold differing views on the impact of import tariffs on inflation. Some believe the transmission effect of tariffs has largely ended, while others argue that tariffs are still pushing up prices, particularly clothing. Morgan Stanley economist Ansoatjee points out that the US economy is nearing the end of the tariff transmission phase, with estimates showing that tariffs have pushed up prices by approximately 63 basis points so far, and the total transmission amplitude is close to 70 basis points, with early signs of slowing seen since March. Meanwhile, the US labor market continues to show strong resilience. Data released last week showed that job growth in May exceeded expectations for the third consecutive month, while the unemployment rate remained at 4.3% for the third consecutive month. Although financial markets have begun to anticipate the possibility of interest rate hikes, most economists believe that the threshold for the Federal Reserve to tighten monetary policy remains high. ING's chief international economist, Knightley, stated that if core inflation shows signs of transmission—that is, rising energy costs are also reflected in other categories—this would be a trigger for the Fed's interest rate hike narrative, but currently, the central bank still considers its monetary policy stance to be somewhat contractionary.

Summarize

In summary, the US Consumer Price Index (CPI) report for May is likely to present a complex inflation picture: the overall CPI hit a three-year high due to soaring gasoline prices, while the core CPI slowed as the one-off effect of rent payments subsided. This divergence makes the Federal Reserve's policy decisions more challenging. For ordinary American households, inflation exceeding wage growth for two consecutive months means declining real purchasing power and accelerated depletion of savings. For the Trump administration, a high-inflation environment will undoubtedly be the most sensitive political issue before the midterm elections. In the coming weeks, the developments in the Middle East and oil price trends will continue to influence the direction of US inflation and the Federal Reserve's interest rate policy stance.

Frequently Asked Questions

Question 1: Why does the market expect the US May CPI to rise by 4.2% year-on-year, a three-year high? What are the main driving factors?

A: The market's expectation of a 4.2% year-on-year CPI increase in May is primarily driven by energy prices, especially the surge in gasoline prices. According to data from the U.S. Energy Information Administration, the average gasoline price across the U.S. rose 8.8% in May, reaching $4.60 per gallon. This increase is attributed to the U.S.-Israel military strikes against Iran since the end of February, which escalated geopolitical conflicts in the Middle East and caused international oil prices to surge by more than 50% at one point. Although oil prices have fallen somewhat after the recent ceasefire agreement, the overall price level in May was still significantly higher than in previous months, thus pushing up the year-on-year inflation reading for that month. Furthermore, the relatively low base from the same period last year also amplified this year's year-on-year increase to some extent.

Question 2: Why is the core CPI expected to slow down in May? What does it mean that the one-off shock to rents is fading?

A: Core CPI excludes volatile food and energy prices. The market expects core CPI to rise 0.3% month-on-month in May, lower than April's 0.4%. The main reason for the slowdown is that the "one-off shock of rents" is fading. Last year, the US government shutdown prevented the timely collection of some economic data. When the government resumed operations, the Department of Labor made a technical one-off adjustment to the rent indicator, which artificially boosted core inflation readings in the past few months. As this adjustment effect gradually disappears, the upward pressure of rents on core CPI also weakens, so the monthly increase in core inflation is expected to decline. It is important to emphasize that this does not mean that actual rent levels are falling, but merely that the impact of statistical methods is gradually fading.

Question 3: What does it mean for the average American family if inflation has outpaced wage growth for two consecutive months?

A: When the inflation rate exceeds the wage growth rate, it means that workers' real purchasing power is declining. In other words, even if nominal wages increase, the goods and services that can be bought with those wages decrease. Inflation is projected to outpace wage growth for the second consecutive month in May, forcing many households to draw on their savings to cover everyday expenses such as food, gasoline, and housing costs. RSM Chief Economist Brusuelas points out that if this situation continues, it often foreshadows a severe challenge to household consumption in the second half of the year. Consumption is a major engine of US economic growth; if households reduce spending due to shrinking real income, overall economic growth could be dragged down, even risking a slowdown.

Question 4: With inflation soaring, will the Federal Reserve raise interest rates? Why do economists believe the threshold for raising interest rates remains high?

A: Although financial markets have begun to anticipate the possibility of interest rate hikes, most economists believe the threshold for a Fed rate hike in the near term remains high. There are three reasons for this: First, the Fed is more focused on the core PCE inflation indicator, and the current signs of slowing core CPI and the fading one-off rent shock lead the central bank to believe that current inflationary pressures may be temporary. Second, the Fed believes that its current monetary policy stance is already somewhat contractionary, and further rate hikes could excessively dampen the economy. Third, while the US labor market is performing strongly, the unemployment rate remains stable at 4.3%, showing no signs of overheating. ING's chief international economist, Knightley, stated that only when clear "transmission signs" of core inflation are observed—that is, rising energy prices begin to spread widely to other categories such as the service sector—will the Fed shift its narrative towards rate hikes.

Question 5: What role have import tariffs played in the current round of inflation in the United States? What are the disagreements among economists on this issue?

A: There is a clear divergence of opinion among economists regarding the impact of import tariffs on inflation. Some believe the transmission effect of tariffs has largely ended. Morgan Stanley economist Ansoatjee estimates that tariffs have pushed up prices by approximately 63 basis points so far, with a total transmission effect approaching 70 basis points, although early signs of a slowdown have appeared since March. Other economists believe that tariffs are still pushing up prices, especially for consumer goods such as clothing. In summary, tariffs did indeed play a role in fueling inflation in the early and middle stages of this round, but their marginal impact is diminishing as the tariff increase efforts come to an end. However, because the speed and duration of tariff transmission vary across different product categories, the ultimate impact on overall inflation remains somewhat uncertain.