Huachuang Securities: The US CPI in May once again slightly fell short of expectations. Can concerns about tariff inflation be alleviated?

According to the Zhitong Finance APP, Huachuang Securities released a research report stating that the U.S. CPI in May once again slightly fell short of expectations. The CPI year-on-year rose from 2.3% to 2.4%, while Bloomberg expected 2.5%; the core CPI year-on-year remained flat at 2.8%, with Bloomberg expecting 2.9%. The CPI month-on-month was 0.1%, lower than the expected and previous value of 0.2%; the core CPI month-on-month was 0.1%, with an expectation of 0.3% and a previous value of 0.2%. Unless Trump continues to suspend or cancel reciprocal tariffs due to negotiations this year, the upward risk of inflation remains a concern. The next two to three months are an important window for the Federal Reserve to observe inflation, and before that, it is highly likely to remain inactive (the CPI situation from June to August can be seen before the September FOMC meeting).

The main points of Huachuang Securities are as follows:

U.S. CPI in May once again slightly fell short of expectations

The CPI year-on-year rose from 2.3% to 2.4%, while Bloomberg expected 2.5%; the core CPI year-on-year remained flat at 2.8%, with Bloomberg expecting 2.9%. The CPI month-on-month was 0.1%, lower than the expected and previous value of 0.2%; the core CPI month-on-month was 0.1%, with an expectation of 0.3% and a previous value of 0.2%. From the perspective of sub-items month-on-month, the CPI increase has slowed down, primarily due to the decline in oil prices affecting energy prices (-1%, previous value 0.7%); secondly, the continuous decline in automobile prices (-0.3%, previous value -0.2%) affecting core goods; thirdly, the increase in rent (0.3%, previous value 0.4%) and super core services (0.06%, previous value 0.21%) has narrowed.

Market expectations for interest rate cuts have warmed, with the futures market pricing the number of rate cuts for the year rising from 1.73 to 1.97 times, the probability of the first rate cut in September rising from 50.9% to 61.3%, and the year-end policy interest rate expectation falling from 3.897% to 3.836%.

Possible factors for the delayed impact of tariffs on inflation

The U.S. CPI has been below Bloomberg's consensus expectations for three consecutive months, possibly influenced by the following factors:

First, the suspension and downgrade of reciprocal tariffs.

Second, some tax avoidance measures at the micro level may have weakened the impact of tariffs. The latest effective tariff rate in the U.S. in April was only 7.07%, significantly lower than the 13-20% estimated by overseas institutions. Some micro tax avoidance measures may have weakened the impact of increased tariff rates, such as transshipment, goods splitting, supply chain adjustments, and the first sale rule. The first sale rule allows importers to calculate import duties based on the first sale price of goods (which have undergone at least two sales before entering the U.S.), reasonably avoiding tariff costs. After Trump imposed tariffs, discussions about this rule overseas have noticeably increased. Unfortunately, the U.S. Customs and Border Protection stated that it could not provide recent data on importers' use of the first sale rule.

Third, the lagging impact of "importing" in the first quarter. In the first quarter of this year, the U.S. goods import value was approximately $163 billion higher than the average level in the second half of last year (by category, industrial products about $79.4 billion, consumer goods about $54 billion, capital goods about $22 billion) Fourth, due to the uncertainty of tariff policies and concerns about declining demand, the transmission of tariff costs by American companies may be delayed. From the manufacturing surveys of various Federal Reserves, the increase in product price indices has been significantly weaker than that of raw material cost indices this year. On a micro level, typical representatives are automobile and grocery retailers. Due to the impact of tariff increases and high interest rates, American automakers have announced discounts and committed to maintaining short-term price stability to cope with weakening demand. Capable retailers may first stabilize their customer base by adjusting the supply chain and sacrificing some gross margins. A recent survey by retail strategy company First Insight shows that nearly 80% of consumers are more loyal to brands that absorb tariff costs.

Can the market's concerns about tariff inflation be alleviated?

Unless Trump continues to suspend or cancel reciprocal tariffs due to negotiations this year, the upward risk of inflation remains a concern. The next two to three months are an important window for the Federal Reserve to observe inflation, and before that, it is highly likely to remain inactive (the CPI situation from June to August can be seen before the September FOMC meeting).

First, American consumer inflation expectations have surged, posing a risk of decoupling. In the face of a major inflation cycle, consumer inflation perception is more sensitive, and the upward timing of consumer inflation expectations is about 1-2 quarters earlier than the actual inflation upward timing. For example, in 2021, 2009, and 2002, the current one-year and five-year inflation expectations of American consumers remain at near 45-year and near 25-year highs, respectively.

Second, the market's inflation forecasts still imply concerns about rising inflation. Although there has been a downward adjustment since May, the Bloomberg consensus expectation for year-on-year CPI in the second half of this year remains as high as 3.3%, compared to about 2.4% at the end of last year, about 2.6% in February, about 2.8% before reciprocal tariffs, and a peak of about 3.5% in May.

Third, from corporate surveys, the pressure of price transmission still exists. The raw material price index in various Federal Reserve manufacturing surveys has significantly increased since February and March of this year, and this type of index generally leads U.S. inflation by about 1-2 quarters. The latest survey from First Insight also indicates that although 68% of brand and retail executives expect customers to react negatively to retail price increases, 83% of executives still plan to raise prices. From typical companies, even Walmart, which has very strong supply chain management, stated in its May earnings call that (price increases) "will happen in May and will become more apparent."

Fourth, the rush for imports seems to be fading. In April, U.S. goods imports significantly fell back to the average level of the second half of last year.

Fifth, finally, from the structure of the CPI, it does not provide reassurance. On one hand, the inflation impact of tariffs has already been reflected in some CPI components. Aside from clothing and automobiles, prices of highly import-dependent goods such as furniture and home products (0.3%, previous value 0.2%), medical supplies (0.6%, previous value 0.4%), entertainment products (0.4%, previous value 0.4%), and personal computers (1.1%, previous value 0.8%) have continued to rise in the past two to three months. On the other hand, the weakening of super core services month-on-month is an important factor affecting this month's CPI being below expectations, but it cannot be determined whether this weakness can persist. In the past two years, the month-on-month figures for May and June have been weak, but they strengthened again in the second half of the year Risk Warning: Uncertainty regarding U.S. tariff policies and negotiations