Core inflation, however, remains stubbornly high at 5.3%.
By David Enna, Tipswatch.com
The May inflation report, just released by the Bureau of Labor Statistics, brought some welcome news with seasonally-adjusted prices rising just 0.1% for the month and 4.0% year over year, down from a high of 9.1% in June 2022.
Those numbers came in below expectations, but many economists had shifted their estimates slightly lower, so this was not a surprise. Core inflation, which removes food and energy, came in at 0.4% for the month and 5.3% for the year, matching expectations.
The 4.0% annual inflation rate is the smallest increase recorded since May 2021.
This report is a mixed bag. All-items inflation is falling (partly because of very high inflation numbers a year ago) but core inflation is remaining unacceptably high, and surprisingly stable.
Gasoline prices fell 5.6% in May, after rising 3% in April, and are now down 19.7% year-over-year. Prices for the entire energy sector are down 11.7% for the year, a huge factor in the trend of moderating all-items inflation. Other highlights:
- Food at home costs rose just 0.1% for the month and are now up 5.8% year-over year. This is a positive trend for American consumers.
- Shelter costs rose 0.6% for the month and 8.0% year over year. The BLS said shelter costs were the largest factor to the increase in core inflation. Rent costs rose 0.5% for the month.
- The index for used cars and trucks increased 4.4% for the month, but is down 4.2% year over year.
- New vehicle prices fell 0.1% for the month.
- The costs of medical care services fell 0.1% for the month and are down 0.1% year over year.
Here are the 12-month trends in all-items and core inflation, showing the steady decline in overall inflation even as core inflation remains relatively stable above 5.0%:
The decline in the annual inflation rate should continue through June, because U.S. inflation increased 1.37% in June 2022, a shockingly high number. So we should see the official U.S. inflation rate dip below 4.0% in the June report, but after that it should stabilize or potentially rise because year-ago numbers cooled off dramatically from July to the end of 2022.
So while today’s numbers mark a positive trend, in a few months we could see that trend reversing, with U.S. annual inflation inching higher or even moving sharply higher if energy prices reverse.
What this means for TIPS and I Bonds
Investors in Treasury-Inflation Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates for I Bonds. For May, the BLS set the CPI-U inflation index at 304.127, an increase of 0.25% over the April number.
For TIPS. The May inflation report means that principal balances for all TIPS will increase 0.25% in July, after increasing 0.51% in June. Here are the new July Inflation Indexes for all TIPS.
For I Bonds. The May inflation report is the second of a six-month string that will determine the I Bond’s new variable rate, which will be reset November 1. So far, inflation has increased 0.76% in that period, which translates to a variable rate of 1.52%. But four months remain.
Also, in the July to December period, you can expect non-seasonally adjusted inflation to run slightly lower than the official seasonally-adjusted numbers. This happens every year. Here are the numbers I am tracking:
What this means for future interest rates
My immediate reaction is that the Federal Reserve can go ahead with its planned one-month pause in raising interest rates. That announcement is coming tomorrow. Today’s inflation report matched expectations. But there is nothing here to celebrate, given that core inflation remains stubbornly high and the inflation trend from July through the end of 2023 could move higher.
After this one-month pause, who knows? The June inflation report, coming July 12, is likely to look benign, which would leave the door open for a longer or even permanent pause. From this morning’s Bloomberg report:
“This is a pretty good print in terms of signaling that we are likely to see the core CPI soften materially starting next month,” Omair Sharif, president of Inflation Insights LLC, said in a note. “The way things are going now, I suspect we’ll see a soft core that will tamp down odds of a July hike.”
A lot will depend on the price trend later in 2023. It seems likely the Fed has not yet hit its “terminal rate,” and is highly unlikely to begin cutting interest rates this year.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
Paul Krugman has been mentioned. When has Krugman ever been right about ANYTHING? (A single example will do.)
Perhaps winning a Nobel Prize? I don’t know?
If not that, then sharing a birthday with me!
Look up Krugman in the index of the book “Econoclasts” by Domitrovic and you’ll get a hint of Krugman’s actual and abysmal track record when it comes to forecasting.
I’ve enjoyed this conversation about Paul Krugman. Some thoughts:
Paul Krugman won the Nobel Prize for economics in 2008 for his work on international trade. So he definitely has credibility. However, he also has a history of promoting liberal economic policies and dismissing the threat of inflation and the dangers of U.S. budget deficits. I’m not being political here, just stating facts. He promotes using fiscal and monetary policy to create lower unemployment and a stronger economy, while also running up deficits. In this June 16, 2023, article, he is dismissing the validity of how we measure “core inflation” and making the case that shelter inflation is being overstated. (Of course, in the 2020 to 2022 period it was the reverse and being understated, at a time Krugman was encouraging more aggressive Fed stimulus.) His shelter idea could be true, but there are indications that rents are still increasing around 1.5%, so that’s certainly not deflation.
I have access to Krugman’s NYT archive, so I took a look. He writes a lot of columns and he is very good, an excellent communicator.
On June 21, 2021 — when U.S. inflation was at 5.4% — he wrote a column titled “The Week Inflation Panic Died” arguing that the then-current-surge in inflation was transitory and would soon be resolved.
On May 6, 2021 — when U.S. inflation was 5.0% — he wrote a column with the headline “Who’s Afraid of the Big Bad Boom?” saying there was no evidence that inflation was getting embedded into the U.S. economy.
On March 22, 2021 — when U.S. inflation was 2.6% — he wrote “How Not to Panic About Inflation,” arguing that inflation after the 2008 Fed stimulus was a temporary blip and that the $1.9 trillion American Rescue Plan would cause only a minor increase in inflation, if at all. “Don’t panic,” he said.
Krugman and many other liberal economists WERE WRONG in this lead-in to high U.S. inflation. Again, I am not attempting to be political. I am definitely not a conservative, but I did understand one thing … that massive government spending COMBINED with aggressive stimulus from the Fed were highly likely to cause a dangerous surge in inflation.
I respect Krugman, but I do think his political viewpoint shades his economic opinions.
Paul Krugman’s take that the standard measure of core inflation is strongly affected by data that is very out of date.
This article touches on what I had mentioned early. The possibility of higher prices creeping into the market under the guise of higher costs (due in part to higher costs on money).
https://finance.yahoo.com/news/the-us-is-now-facing-a-third-inflation-wave-economist-explains-075029389.html
Very interesting. Three waves of inflation. Thanks for posting.
In the link: “Here are the new July Inflation Indexes for all TIPS.” What do the numbers listed in the Ref CPI column refer to? For example 303.363000. I can not find a explaination anywhere on the Treasury Direct site or with Google queries.
The Bureau of Labor Statistics sets a CPI-U index number for each month, and it reports it in each monthly inflation release. This is non-seasonally adjusted inflation. That number is used to set daily inflation accruals for TIPS, two months in the future. (So the May number is used for daily accruals in July.) You can find a list of these inflation indexes going back to 1971 on this page: http://eyebonds.info/tips/cpi/cpibig_05.html
Got it. I really apprectiate your site and look forward to every new post. Thank you.
Powell really embarrassed himself today. He keeps saying the Fed makes decisions based on data (employment and core inflation), but today they ignored the data. Notice he did not answer the first question, but went off on some tangent about the pace of rate hikes.
He was very nervous today, which means he is not saying what he really thinks. Whenever a politician or academic concludes “That seems reasonable”, you can be sure it is not.
If they really believe their projection of a terminal rate at 5.6%, there is absolutely no reason to pause. Well, it does not bother me personally, since pausing means they will have to raise higher later. But the inconsistencies are worrisome. These people are supposed to be intelligent.
The pause was signaled because of the recent banking crisis and the potential for more disruptions. I think the Fed is reluctant to say rate hikes have ended, even though they might have. I was fine with this pause. The June all-items inflation number is going to look good, I think, so that is going to put pressure on the Fed to hold rates again at the July meeting.
OK, sounds like a plausible explanation. Not everyone can translate higher costs into higher prices. My HOA does, my County does, my timeshare _maintenance fees_ does. (they all have a captive market) However, it becomes difficult for me to get higher prices if I rent a property or timeshare, at least in the short run.
Although it’s too early to say, we can always speculate.
If the monthly inflation rate for I Bond purposes averages an increase of .25 for the next four months, the same as last month, we will end up with a 1.76% increase for the next six month period, or a 3.52% inflation rate for the November 1 rate change. This is similar to, but slightly higher than, the current period of 3.38%, reversing the downward trend from the last two semi-annual periods and effectively stabilizing in a narrow range.
This begs the question, how does this compare to the average I Bond inflation rate since inception?
More speculation…with short+term treasuries showing signs of having peaked, and the Fed likely pausing rate hikes, the I Bond fixed rate could drop slightly, making the current period, ironically, the better time to buy long-term and, at the same time, the better time to sell short-term to minimize the three month penalty if holding less than five years (although the difference would be negligible).
I wouldn’t try to forecast the November reset based on just two months of data. Inflation in summer months can be quite volatile, and non-seasonal inflation tends to run low from July to the end of the year. On the history of I Bond fixed and variable rates, I have those listed at the bottom of this page: https://tipswatch.com/qa-on-i-bonds/ …. Also it’s too early to speculate on the I Bond’s next fixed rate, but I do think the current rate of 0.9% is good enough to lock up with at least one maximum purchase or if that isn’t possible, a gift box swap.
In October, I will sell the bonds I purchased in Nov-21 and Jan-22 and purchase the current bond with the 0.9% fixed rate. In April 2024, I plan to sell the bonds I purchased in Oct-21 and Apr-22 to buy the next bond (issued in November) in the expectation that it will also have a high fixed rate. I’m willing to take the 3-month interest penalty because bonds with a positive fixed rate will always outperform bonds with a zero fixed rate.
Rolling over I Bonds with a 0.0% fixed rate to capture a 0.9% fixed rate makes sense, although I’d generally prefer to hold I Bonds until I need the money. I will be doing a rollover later this year (gift-box strategy), but with 0.0% I Bonds I have held 5 years, so no penalty.
Looks like a good plan. I am looking to get rid of 0% fixed rate bonds to the largest extent possible over time.
“The decline in the annual inflation rate should continue through June, because U.S. inflation increased 1.37% in June 2022, a shockingly high number.”
Think you have a typo. Unadjusted year over year inflation in June of 2022 was 9.06%
I see what you did there. 1.37% is the monthly increase from May 2022 to June of 2022 in the unadjusted, all items index. Annualized that was 17.8% which was truly shocking!
Yes, I was talking about the month of June, not the annual rate.
Just copied this from online Barron’s post Janet Yellen’s testimony:
“…Given the government’s now-increased borrowing capacity, there have been worries that the Treasury will spark market volatility by issuing a significant amount of new Treasuries quickly. Noting that it is the Treasury’s obligation to rebuild the department’s balance to “a safe and appropriate level,” Yellen said the department will be issuing a “substantial” quantity of Treasury bills and cash-management bills in the coming months.
Yellen said the Treasury had consulted widely with market participants about how to rebuild levels in a way that minimizes the cost to the federal government and avoids market disruption to the extent possible. “As we build our balance, we will certainly be careful to see if there are impacts or market disruption,” she said….”
Core inflation was up month-on-month .43%, which annualized is 5.16%. The sad fact for the Fed is that core inflation has not changed much since December 2021, almost a year and a half ago. Considering employment is robust, real consumer spending is doing fine, and Fed funds rate and 30 year fixed mortgage rates are about average (1971-2022), it would seem strange for the Fed to pause. If they do pause, it is capitulation to Wall Street and Powell will lose credibility. Of course anything is possible.
I think the banking crisis spooked the Fed and it wants to see if there will be more fallout. I think the Fed knows it is near the end of rate hikes, but will probably do 25 to 50 basis points more and then hold.
I agree.
“Core inflation was up month-on-month .43%, which annualized is 5.16%.”
.43% monthly inflation rate annualizes to 5.28%. The formula is (1+.0043)^12-1 and not .43 * 12
It is just a hypothetical extrapolation, a rough and ready estimate.
Then use the word approximately so we are aware that it not a true rate.
Ohviously any projection is going to be an estimate. I don’t have a time machine.
When you convert a rate from one time period to another that is not an extrapolation. It is arithmetic.
I was exactly “extrapolating”one month to 12 months. It is a way to annualize data. It is a common practice. For example, Treasury annualizes all its Treasury rates, one month, three month, six months, all the way up to thirty year. It allows one to compare rates across different periods. BTW, any manipulation of numbers is arithmetic.
“If you find yourself in a hole, stop digging.”
― Will Rogers
Yes, Treasury annualizes all of its Treasury rates, but they don’t screw up the arithmetic.
On the Treasury auction results, I’m having trouble understanding the difference between the High Rate and the Investment Rate.
Wouldn’t they be the same?
Today’s 1 year auction had a high rate of 4.93% but the investment rate was 5.208%.
I’m probably missing something, but I thought the high rate was the highest rate at which the last bill would be sold. And all lesser bids would get this same rate.
The investment rate is defined as “equivalent coupon-issue yield”. What is that? These T-bills are sold at a discount and then mature at full par value; there is no coupon. So the investment rate is meant to mimic the return of a coupon-paying investment like a bank CD. The high rate is the actual auction result but the investment rate gives a better picture of the yield.
If you buy at auction you should get the investment rate.
Thank you for the timely and excellent summary.
Yes, the probability of no more rate increases and, so called, soft landing seems to be going up, while, so far, there seems to be no need for a rate cut this year. It’s good to also have stocks for growth in our portfolio.
I understand the rationale behind raising interest rates to damp inflation as it takes away easy low cost money from the supply side. But doesn’t also higher interest rates translate into higher costs for producing goods and services and thus push for higher prices? Is that ever taken into account?
That’s more of a time argument. Many believe ‘rate shock’ i.e. a very rapid rise (like Volcker did) is better than relatively slow hikes (like Burns, and now Powell, did). This is because business doesn’t have time to upward adjust prices based on higher costs due to higher rates. However, when high rates drag on, ofc they incorporate that.
Right now rent vs mortgage is the best example. Rent is paid to use an asset that is almost always financed be it a house or an apartment complex. Even if not financed, there’s opportunity cost of using cash (i.e., you can get 5% with 100% safe investment in a Treasury, and you don’t have to replace a roof or AC periodically). Right now, it is not profitable to mortgage a house and rent it out (in the aggregate), which means anyone buying a house on credit today and then renting it out is losing money. The market can ride for a while with people renting out houses they bought 1+ year ago, but obviously not indefinitely. Either people will stop adding supply to the rental market, rates will come down, house prices will come down, rents will go up, or some combination of the 4.
I think it’s impossible to quantify accurately. I’m mostly pointing out that the longer rates are high, the more the cost of the higher rates creeps into prices. But, it’s not a quick thing at all, it’s very slow. The vast majority of housing for example, was not built in the last 12 months.