May's missing inflation is a mystery — and a sign that the Fed will hold off on rate cuts

May's CPI data revealed a modest 0.1% increase, holding under 2.5% year-over-year for the third month, driven by declines in volatile categories like gasoline and eggs, as well as easing housing inflation. Surprisingly, tariff-impacted categories such as new vehicles and apparel also saw price decreases, contributing to core inflation hitting its lowest level since 2021 for the third consecutive month. This unexpected absence of tariff-driven inflation may lead the Federal Reserve to delay potential interest rate cuts.

Analysis

May's U.S. inflation data presented a surprisingly benign picture, with the consumer-price index rising only 0.1% from April and remaining below 2.5% year-over-year for the third consecutive month. This subdued inflation was driven by declines in volatile components, such as gasoline and eggs which both fell over 2% month-over-month, and a significant slowdown in housing inflation, evidenced by rent of primary residence registering its smallest increase since 2021. More unexpectedly, categories anticipated to reflect U.S. tariff impacts, including new vehicles (down 0.3% from April), used cars and trucks (down 0.5% from April), and apparel (down month-over-month and year-over-year), all experienced price decreases despite leaner dealer inventories for vehicles. This contributed to core inflation holding at its lowest level since 2021 for a third straight month. The absence of anticipated tariff-driven price hikes introduces uncertainty, suggesting the Federal Reserve may adopt a more cautious stance and delay interest rate cuts as it assesses whether these tariff effects are truly absent or merely delayed, and will be less willing to bet on such increases being 'transitory'.

Key Decisions for Investors

• Investors should temper expectations for near-term Federal Reserve rate cuts, as the unexpected lack of tariff-driven inflation in May's CPI report suggests the Fed may remain cautious.
• It is advisable to closely monitor upcoming inflation data for any delayed pass-through effects of tariffs, particularly in vehicle and apparel sectors, as this 'missing inflation' complicates the monetary policy outlook.
• The current ambiguity surrounding tariff impacts and inflation persistence warrants a patient approach when forecasting changes in monetary policy, as the Fed may wait for more clarity before signaling any easing.