Inflation is cooling – latest data proves

Investors got some positive news on Tuesday after one popular measure of inflation fell sharply to two-year lows. The Labor Department reported the consumer price index (CPI) rose 4% year-over-year in May. That’s well off the 4.9% gain in April and a touch below the 4.1% figure economists were expecting. This is only the latest sign that the Federal Reserve is making solid progress in its ongoing battle against inflation. CPI inflation hit a 40-year high of 9.1% in June 2022, and it has been steadily falling over the past 12 months. The Fed is holding its regularly scheduled policy meeting this week, and investors are ever more confident that the central bank will pause its campaign of rate hikes now that inflation is on the mend. CPI by the Numbers A combination of higher interest rates, easing supply chain constraints and tighter credit has helped tame inflation in 2023. As of May, the annualized rate of CPI inflation has declined for 11 months straight. In May, core inflation—which excludes volatile food and energy prices—was up 0.4% on a monthly basis and 5.3% from a year ago. Food prices were up 0.2% month-over-month and 6.7% compared to a year ago. Energy prices were down 3.6% on a monthly basis and are down 11.7% over the past 12 months. Shelter costs continue to rise, gaining 0.6% compared to April and 8% compared to May 2022. The latest CPI numbers arrive after the Labor Department reported the U.S. economy added 339,000 jobs in May, showing that the jobs market remains incredibly strong. Wages were up 4.3% year-over-year in May, while the unemployment rate ticked higher to 3.7%—figures that further underline the unflagging strength of the U.S. labor market. The May inflation reading is only the latest data showing meaningful progress on inflation. In May, the Commerce Department reported the core personal consumption expenditures (PCE) price index was up 4.7% in April, a slight increase from a 4.6% year-over-year gain in March.

Core PCE is the Fed’s preferred inflation measure.

The Fed Is Winning the War on Inflation

Inflation has been the Fed’s enemy No. 1 since early 2022, and the Federal Open Market Committee has made aggressive changes to U.S. monetary policy in an attempt to lower inflation to its long-term target of 2%. In May, the FOMC raised its target federal funds rate by one quarter of a percentage point, its tenth consecutive interest rate hike. Since March of last year, the Fed has raised fed funds by 5% to its current range of between 5% and 5.25%. The FOMC is also allowing up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities (MBS) to mature and roll off its more than $8.3 trillion balance sheet per month. In May, Fed Chair Jerome Powell said a U.S. banking crisis that included the collapses of Silicon Valley Bank, Signature Bank and First Republic Bank has tightened credit markets. Thanks to the crisis, Powell noted, “our policy rate may not need to rise as much as it would have otherwise to achieve our goals.” The May CPI reading likely increases the chances the Fed will announce a pause to rate hikes at the conclusion of its meeting on Wednesday, June 14. According to CME Group, markets are currently pricing in a 93% chance of a pause in rate hikes this week and just a 7% chance of a rate hike. However, the market is also pricing in a 74.3% chance the Fed will raise rates by at least another quarter of a percentage point by the end of July. Markets Believe Inflation Is on the Mend David Bahnsen, chief investment officer at The Bahnsen Group, says Tuesday’s CPI report is a clear sign the Fed has won its battle against inflation. “Tuesday’s CPI suggests that inflation has been defeated,” Bahnsen says. “:Most of the inflation we are seeing is coming from housing, but it takes time for home price declines to show up in the CPI data, so today’s 4% inflation rate is actually much closer to the 2% Fed target.” The central bank is attempting to navigate a balancing act of aggressively raising interest rates to bring down inflation without tipping the U.S. economy into recession. Higher interest rates increase borrowing costs for companies and consumers, slowing economic activity. Up to this point, the U.S. labor market and stock market have mostly shrugged off inflation and rising interest rates. The S&P 500 is up 12.6% year-to-date as investors seemingly anticipate a soft landing for the U.S. economy. In fact, the S&P 500 officially entered bull market territory in early June, surpassing a 20% gain from its October 2022 lows.