Is the slowdown in the U.S. May CPI an illusion? Structural pressures still exist, and the Federal Reserve may adopt a wait-and-see approach this summer

Despite the better-than-expected CPI data in May, the inflation pressures faced by the Federal Reserve are far from dissipating—core commodity prices are quietly rising, service sector inflation remains stubborn, and wage growth for the bottom 25% income group has even fallen below pre-pandemic levels. The market's expectations for Federal Reserve policy have remained almost unchanged, which may be the most genuine signal.

The "Beautiful Illusion" of Surface Data

The latest data shows that the U.S. Consumer Price Index (CPI) continued its downward trend in May, marking the first complete month of data since the full implementation of Trump's tariff policy.

According to Xinhua News Agency, on April 2, U.S. President Trump signed two executive orders regarding the so-called "reciprocal tariffs" at the White House, announcing a 10% "minimum benchmark tariff" on trade partners and imposing higher tariffs on certain trade partners.

From the perspective of the four major components—food, energy, remaining goods, and services—the overall pattern has changed very little. The service sector continues to dominate inflation trends, energy prices are negative, food prices are rising, and while core commodity inflation, which is most affected by tariffs, has increased, the extent is almost imperceptible.

The market seems to have already priced in a decline in CPI. The Morgan Stanley team indicated before the data release that the swap market was suggesting that the May CPI data would unexpectedly decline.

However, the detailed data from the Atlanta Fed reveals hidden problems. The Atlanta Fed categorizes inflation into flexible-price products and "sticky" products—price changes take time to implement, and rate cuts are rarely seen.

In the past three months, flexible-price products have declined, possibly due to weak demand, while sticky product inflation has decreased very slowly. The Cleveland Fed's trimmed mean inflation measure has risen for the first time this year, remaining above 3%, indicating that underlying inflation pressures persist.

"Super Core" Inflation Resurfaces

Another issue facing the Federal Reserve is the rise of "super core" inflation (excluding housing services), which the Fed has consistently prioritized.

Although the overall contribution of goods to CPI remains small, it is steadily increasing, even without the step changes that new tariffs might bring.

The most politically sensitive prices are also continuing to rise.

The "Common Person Inflation Index" tracked by Strategas Research Partners shows that the prices of basic necessities have consistently "outpaced" income growth during Biden's term, becoming a key factor in the Democrats losing the White House. Under Trump, the price increases of basic living goods still exceeded wage growth.

Bottom Income Groups Suffer Double Blow

According to census data, the WageTracker data from the Atlanta Federal Reserve Bank brings more bad news for low-income groups.

The data shows that overall average wage growth has remained slightly above 4% for the third consecutive month, but this stability comes at the expense of wage declines for the lowest 25% income group. Regardless of how businesses respond to current challenges, the outcome seems to be more unfavorable for the lowest-income employees, whose wage growth has fallen below pre-pandemic levelsAt the same time, the sharp rebound in oil prices casts a shadow over the inflation outlook. Concerns from Iran have driven oil prices to the largest single-day increase of the year, and the short-term downward trend seems to have been decisively broken.

The Federal Reserve's Dilemma in the Summer Wait

Market expectations for Federal Reserve policy have been almost unaffected by the May CPI: a rate cut is expected in September, with another possible in December.

Don Rissmiller of Strategas believes:

"Tariffs are destroying consumer demand, so there is reason to shift monetary policy to neutral," but the arbitrary enforcement of tariffs means "the next Federal Reserve rate cut may still be a while away" — likely not until the fourth quarter.

Troy Ludtka of Sumitomo Mitsui Trust Securities argues:

"To ensure that there is no lagging inflation rebound caused by tariffs in the next three inflation reports (June, July, August), we expect the Federal Reserve to wait until September to cut rates."

In a situation where inflation has not yet been fully tamed and trade policies are fraught with uncertainty, the Federal Reserve's choice to remain on hold may be the least bad option. However, for those at the bottom whose wage growth has fallen below pre-pandemic levels, this summer is bound to be long.

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