- Key insight: Inflation hit 4.2% last month, the highest annualized increase in three years. The reading follows a strong jobs report last week.
- Expert quote: "It's possible that we're not going to see any more rate cuts and the long-term equilibrium ends up settling at 3.5 percent or higher. If I was the CFO of a bank, I'm not saying that would be my base case, but I would be running stress scenarios that reflect a much higher rate environment." — Mark Zandi, chief economist, Moody's Analytics
- Forward Look: The high inflation reading has scuttled any plans to lower interest rates in June. The question is whether interest rate cuts are off the table for the foreseeable future.
Inflation hit its highest reading in three years last month, giving the Federal Reserve little choice but to keep its benchmark interest rate unchanged at next week's meeting. But what happens after that is anyone's guess.
Headline inflation climbed by half a percentage point in May, hitting an annualized rate of 4.2%, according to the Bureau of Labor Statistics'
The report all but locks the Federal Open Market Committee into keeping the target rate for the federal funds rate unchanged at its meeting next week — an outcome many on the monetary policy-setting committee were
With some FOMC members willing to look past elevated inflation as the result of one-time economic shocks and others concerned about inflation expectations among the general public becoming unmoored, Tang said interest rates could end the year higher or lower than they are today. He noted that this uncertainty is reflected in bond prices over a broad array of maturities.
"We're already seeing some kinks in the yield curve," Tang said, alluding to the fact that bond yields are not increasing linearly with maturities. "The shape of the yield curve is going to continue to look less smooth because people are trying to balance the uncertainty of inflation, a new Fed chair and, over the long run, possible disinflation from AI and a much friendlier bank regulatory environment."
The May CPI surge was largely expected and driven by a spike in energy prices resulting from the
The inflation reading follows a
"I am prepared to be patient in holding policy at its current restrictive setting as we watch how the conflict evolves and what impact there is on inflation and inflation expectations," Fed Gov. Christopher Waller said in a
Despite this more inflation-wary rhetoric, some market observers believe the FOMC is not yet contemplating a rate hike. In an analyst note, Michael Pearce, chief U.S. economist at Oxford Economics, said he expects newly installed Fed Chair Kevin Warsh to "push the committee" to balance concerns about near-term headline inflation against price stability in core pricing categories and the "disinflationary effects of strengthening productivity growth."
"Hawkish chatter around the Federal Open Market Committee has become much louder, but the bar for a rate hike is high, and we still expect an improving inflation outlook to justify cuts by year-end," wrote Michael Pearce, chief U.S. economist at Oxford Economics and author of the analysis.
Warsh came into office advocating easier monetary policy and a focus on "trimmed mean" inflation, which omits not just food and energy but all price categories that change substantially relative to the broader index. Fed Vice Chair for Supervision Michelle Bowman
"Looking through temporary inflation shocks may be appropriate to achieve optimal policy, as long as doing so does not affect our credibility to bring inflation back to 2%," Bowman said in remarks delivered at an economic conference on May 29. "The tricky part is understanding what may or may not have persistent effects on inflation."
In light of the most recent inflation and employment reports, some analysts see the possibility of a so-called "good news" rate cut — one brought on by a significant drop in inflation — as all but off the table. Mark Zandi, chief economist at Moody's Analytics, said it would take a recession for the Fed to lower rates in 2026.
Even if the economy slows and unemployment begins to rise, Zandi said, the Fed could be reluctant to make its policy rate more accommodating until inflation returns to its target rate of 2%, precisely because of the expectation concerns noted by Waller, Bowman and others.
Beyond the near-term outlook, Zandi said other factors — such as erosion of trust in the U.S. as a safe haven for capital, an ever-climbing national debt and shaky confidence in the Fed's ability to set policy independent of the White House — suggest that we have already seen the lowest rates of the current economic cycle.
"It's possible that we're not going to see any more rate cuts and the long-term equilibrium ends up settling at 3.5 percent or higher," Zandi said. "If I was the CFO of a bank, I'm not saying that would be my base case, but I would be running stress scenarios that reflect a much higher rate environment."
