Inflation Runs Hot Again: A Tale of Headline and Core

DEWITT, Mich. - June 14, 2022 - PRLog -- This week the biggest market-moving economic data arrived on Friday, with the release of the U.S. consumer price index (CPI) inflation reading for the month of May. The inflation data broadly came in hotter than expectations, with the headline figure coming in at 8.6% year-over-year, above expectations of 8.2%, while core CPI (excluding food and energy) came in at 6.0%, slightly above the 5.9% forecast.

While markets fell nearly 5% this week as risks to growth rise, we do not believe a recession is inevitable here, and with the market pullback already pricing in a fair amount of pessimism toward the economic outlook, we view the upside versus downside in markets as more compelling today.

Headline and core inflation diverge meaningfully

Headline inflation, driven by rising oil and food prices, has moved substantially higher over the last few months, while core inflation has shown signs of very gradual easing. Of note, this month we saw the widest differential between headline and core inflation that we've seen in the past 10 years.

What is driving headline inflation higher?

The key driver of headline inflation continues to be rising global food and energy prices. With uncertainty in the Ukraine war (which continues to be difficult to handicap) and China's reopening driving demand, commodity prices may remain stubbornly elevated over the next several months. WTI crude oil prices, for example, were up nearly 9% in the month of May, and now are up about 7% in the first few days of June alone, hovering around $120¹.

However, while the Federal Reserve may attempt to temper consumer-discretionary demand by raising interest rates, its actions generally do not impact global commodity prices or the demand for consumer staples, like food and energy. Thus, the Fed's focus tends to lie more on fighting core inflation, which is starting to see a downward trend, albeit very gradually.

What could drive core inflation lower?

Perhaps the one silver lining in this month's CPI report is that we saw a modest decline in core inflation, from 6.2% to 6.0% year-over-year. This was driven in part by better prices for medical care and transportation services. However, there may be opportunity for further reprieve in areas like used- and new-car prices and airline fares, which remained high this reading but could trend lower in the months ahead.

Overall, our base-case scenario continues to call for inflation to moderate somewhat by year-end, driven by base effects (more favorable yearly comparisons) and better trends in core inflation. However, given rising food and energy prices, risks for a bear-case scenario are rising in the near term as well.

Source: 1. FactSet