Tonight's US CPI - The first real test of tariff inflation transmission

The CPI data for May, to be released tonight, will become a watershed moment for the U.S. economy. With hard data testing the transmission effects of Trump's tariff policy on consumer prices being published for the first time, the results could completely rewrite the Federal Reserve's interest rate cut expectations and the market's risk pricing logic.

Goldman Sachs warns that although only 10-20% of the CPI basket will be directly affected by tariffs, pricing power and behavioral responses may amplify the impact. More critically, this round of tariff-driven inflation shocks may force the Federal Reserve to reassess the criteria for "transitory" inflation, while investors are preparing for a "painfully asymmetric" market reaction—where the shock of inflation exceeding expectations is far more severe than the comfort of falling short of expectations.

The Critical Point of Tariff Transmission

At 20:30 Beijing time on Wednesday, the U.S. Bureau of Labor Statistics will release the May Consumer Price Index (CPI) report. According to economists surveyed by the media:

The U.S. May CPI is expected to grow by 0.3% month-on-month, consistent with April's increase;

The U.S. May CPI is expected to grow by 2.5% year-on-year, up from 2.3% in April, with a forecast range of 2.2-2.7%;

The U.S. May core CPI is expected to grow by 0.3% month-on-month, compared to 0.2% in April;

The U.S. May core CPI is expected to grow by 2.9% year-on-year, up from 2.8% in April, with analysts predicting a range of 2.7-3.1%.

In terms of expected distribution, the current expectation for the core CPI month-on-month is significantly skewed towards the lower 0.2% figure, but many forecasters expect this number to be 0.4% or higher.

Economists unanimously agree that the May CPI data will mark the beginning of tariff-related inflation readings, and this shock may last until the end of the year.

Ronnie Walker, a senior U.S. economist at Goldman Sachs, stated that the firm expects a moderate increase of 5 basis points in the core CPI month-on-month this month, primarily reflected in categories such as entertainment goods (like Xbox), communication goods, and furniture.

What is more concerning is the trend of amplifying transmission effects. Walker stated:

In subsequent reports, we expect the impact of tariffs to increase in both magnitude and breadth.

In terms of magnitude, we expect a monthly increase of about 10-15 basis points, with core inflation in June-August reaching around 30 basis points.

Walker also warned that investors may need some time to determine the extent of the inflation transmission from tariff rates:

If relevant discussions can reach conclusions in the next one to two months, this may indicate that the transmission speed and magnitude of tariff prices are relatively fast and large.

However, if there is no clear price increase, it may take more time to completely rule out meaningful transmission effects, and even longer to calibrate a moderate level of transmission effects

If commodity prices do not accelerate significantly, the market may continue to debate in the coming months whether the transmission effect is merely due to delays in the data, or whether it is because exporters, wholesalers, and retailers will bear a larger proportion of tariff costs in the long term, resulting in a smaller transmission effect.

Four Key Trends to Watch

Goldman Sachs highlighted four key component trends in this month's report:

Car Prices: It is expected that used car prices will decline by 0.5% in May, reflecting a decrease in used car auction prices. New car prices are expected to increase by 0.1%, reflecting a cumulative reduction in dealer promotional offers in recent months, which may be related to tariffs.

Car Insurance: Goldman Sachs expects the increase in car insurance prices to be moderate in May (+0.4%), reflecting the rise in premiums shown by online datasets. The increase in car prices, repair costs, and medical and litigation costs has put upward pressure on insurance companies, but the pass-through of premiums to consumers has a high lag.

Tariff-affected Categories: Imposing tariffs on categories of goods that are particularly susceptible to impact will only bring moderate upward pressure. The bank expects that tariffs on goods such as clothing (+0.4%), furniture (+0.4%), education (+0.4%), and communications (flat) will provide a boost in May.

Travel Services: High-frequency price data shows that inflation in travel services is weak in May.

Asymmetric Risk Exposure and Investor Vulnerability

The importance of this CPI data release lies not only in its impact on short-term market volatility but also in its potential to redefine the long-term logic of the Federal Reserve's policy framework and market risk pricing.

As Goldman Sachs global macro researcher Vickie Chang stated:

The market may be more willing to look past negative economic data, as it has been able to remove the worst-case scenarios for growth and inflation from the table. The threshold for data to change the market narrative on Wednesday is quite high.

However, once this threshold is breached, the market may face not just numerical adjustments but a fundamental questioning of the effectiveness of the entire economic policy framework.

Goldman Sachs traders warn that the current market response to inflation shocks shows a clear asymmetry.

The implied volatility of the S&P 500 index is only 0.78%, significantly down from nearly a record 2.4% in April, exposing the market's inadequate preparation for potential shocks.

Goldman Sachs equity portfolio strategist Ryan Hammond believes:

The market rotation reflects that investors are looking past potential economic weakness and pricing in an optimistic yet achievable growth outlook.

The performance of cyclical versus defensive stocks reflects an environment of about 2% U.S. real GDP growth.

However, this optimism may be overly fragile. Goldman Sachs volatility trader Shawn Tuteja warns:

Stock investors seem a bit concerned about the CPI data and how it may continue to drive the current rebound dominated by short sellers.

This could be another reason why people have been covering shorts in the past few days. Our view is quite straightforward—higher-than-expected CPI may reverse the current rebound.

The "Transitory" Narrative on Inflation Faces Challenges

The impact of tariffs on inflation is sparking intense debate within the Federal Reserve, with the core disagreement being whether the impact of tariffs on inflation should be viewed as a one-time "transitory" shock.

Several Fed officials, including Kugler, have explicitly stated that they believe the impact of tariffs on prices may be more persistent.

Goolsbee admitted that he is "somewhat timid" about the narrative that tariffs will have a transitory inflation effect, suggesting that the Fed may have underestimated the lasting impact of tariffs. This stands in stark contrast to traditional central bank practices—officials like Waller, who support the "transitory" view, believe that tariffs will lead to a one-time price increase, and standard central bank practice is to "look through" one-time price shocks.

The consequences of this internal disagreement have begun to manifest in the markets.

The money market is currently pricing in a 45 basis point rate cut by the end of the year, fully pricing in one rate cut, with an 80% probability of a second rate cut. A Reuters Fed survey shows that among 105 analysts, 59 suggested that the Fed should resume rate cuts next quarter, and 60% of economists believe the Fed will cut rates at least twice