The prolonged conflict between the US, Israel, and Iran continues, and the US inflation alarm is sounding again at a high decibel level of 3.8%—the storm has returned. According to a report, data released by the US Bureau of Labor Statistics on May 12 shows that the US Consumer Price Index (CPI) increased by 0.6% month-on-month and 3.8% year-on-year in April, marking the highest level since May 2023. Excluding the volatile food and energy prices, the core CPI rose by 0.4% month-on-month and 2.8% year-on-year in April, reaching the highest level since last September.
Wu Qidi, Director of the Source Information Securities Research Institute, stated that the stickiness of US inflation is significantly increasing. Structurally, this inflation rebound is driven by two factors: on one hand, influenced by geopolitical tensions in the Middle East, the energy index surged by 3.8% month-on-month in April, contributing to over 40% of the monthly CPI increase, with gasoline prices soaring by 28.4% year-on-year. On the other hand, the housing component rose by 3.3% year-on-year, an increase of 0.3 percentage points compared to March, also playing a significant role.
Notably, service sector inflation is rising across the board—overall service prices, excluding energy and housing, increased by 0.5% month-on-month. However, inflation has not yet spiraled out of control. In the view of Lu Zhe, Chief Economist at Soochow Securities, the unexpected rise in US core CPI in April was mainly due to a one-time technical adjustment in housing inflation. After removing the noise from technical adjustments, the core CPI rebounded moderately month-on-month, and the diffusion of inflation remains within a reasonable range, indicating that the "second-round effects" of oil prices on inflation are not yet significant.
For Kevin Warsh, who is about to take the seat of Federal Reserve Chair, what he inherits is not only this set of "scorching" numbers for April but also a policy chessboard that has been fundamentally reset by the fog of the Middle East situation and supply chain restructuring.
Whether inflation will spiral out of control remains unclear. Is the "off-the-charts" US inflation data a short-term phenomenon or a long-term trend? This largely depends on the direction of the Middle East situation. Wu Qidi believes that in the short term, the low base effect will persist for some time, and international oil prices are unlikely to decline rapidly. Overall inflation is highly likely to continue rebounding, but the slope may slow down. In the medium to long term, the unexpected rebound in core inflation and the continuous rise in service sector inflation indicate that the endogenous momentum of US inflation appears relatively strong. Once the transmission path from energy shocks to core inflation solidifies, inflation may evolve from a short-term disturbance to a medium- to long-term trend.
Whether inflation will diffuse remains a key focus for markets and the Federal Reserve, and this largely depends on the subsequent developments in the Middle East situation and oil prices. After excluding the one-time technical adjustment factors for rent inflation and high-volatility items, Lu Zhe found that US core inflation in April did not exhibit the "second-round effects" of oil prices, and forward-looking indicators such as inflation diffusion and long-term inflation expectations remain relatively mild. From a trend perspective, given that oil prices are currently maintained at a high level of $90–$110 per barrel, he expects US inflation to operate around a month-on-month range of 0.4%–0.6% over the next three months, with the inflation peak likely occurring in July.
Looking ahead, whether inflation expectations become unanchored and whether inflation diffuses remain focal points for markets and the Federal Reserve, and this depends on the Middle East situation and oil prices, requiring a step-by-step approach. Under a baseline scenario, as the noise from technical adjustments to housing inflation subsides, if oil prices and inflation expectations do not spiral further out of control, Lu Zhe expects US inflation to exhibit structural characteristics similar to those after the so-called "reciprocal tariffs" in April 2025: in a declining aggregate demand environment, limited supply shocks, while causing price increases for specific goods, will bring greater demand suppression to other sectors, ultimately leading to a decline in inflation rates for other items and core CPI falling below expectations.
Can the new Fed Chair still cut rates? With the release of the latest CPI data, hopes for a Federal Reserve rate cut have almost vanished. The market even expects the possibility of a rate hike by the end of this year to exceed one-third. Wu Qidi stated that, based on current market pricing, the probability of a Fed rate cut within the year is already very low. From more detailed data, financial markets are currently pricing in a probability of over 30% for a 25-basis-point rate hike in December, a significant increase compared to the previous trading day. Behind this sharp reversal in policy expectations is the reality that inflation risks have once again outweighed concerns about slowing employment—since the Middle East conflict at the end of February, rising energy prices have contributed to over 40% of the CPI increase, and cost-of-living pressures have once again become a policy focus.
Regarding the probability of the next rate hike, Wu Qidi believes that the decisive factor will be inflation expectations. A possible scenario is that the Federal Reserve will continue to hold steady in the short term, maintaining the interest rate range of 3.50% to 3.75%, with the probability of a rate cut within the year being extremely low. If subsequent inflation data continues to exceed expectations and service sector inflation further diffuses, expectations for a rate hike from late 2026 to early 2027 will continue to heat up. Currently, the job market is relatively stable, but inflation is rising. If this trend persists, it will increase the probability of subsequent rate hikes.
This poses a particular challenge for the incoming Fed Chair, Kevin Warsh. Warsh has publicly supported rate cuts, and US President Trump expects the Federal Reserve to ease policy. According to a report, the US Senate confirmed Warsh's appointment as a Federal Reserve Governor for a 14-year term on May 12. This is seen as an important step toward his becoming the next Federal Reserve Chair. It is reported that the Senate is expected to immediately initiate the confirmation process for Warsh to also serve as Federal Reserve Chair, with procedural votes possibly completed as early as May 13. Jerome Powell's term as Federal Reserve Chair ends on May 15.
Warsh may find it difficult to persist with rate cuts. Wu Qidi emphasized that the Middle East conflict has fundamentally rewritten market expectations for Federal Reserve monetary policy. The core transmission path of this geopolitical crisis is: the blockade of the Strait of Hormuz leads to a spike in oil prices, persistently high energy prices are amplifying pressure along the supply chain, and US CPI is expected to rise by about 1 percentage point in the coming months. The impact of high oil prices may persist for an extended period, with lagged effects potentially spanning all of 2026. The persistence and transmission scope of this external supply shock have far exceeded previous market assumptions.
Warsh finds himself in a difficult predicament. He advocates for a policy combination of "rate cuts + balance sheet reduction" in the context of AI-driven productivity improvements, arguing that high growth and low inflation can coexist, using this as a theoretical basis for rate cuts. Wu Qidi analyzed that Warsh's policy direction after taking office will be influenced by several factors. First, the inflation data itself—if core inflation continues to exceed expectations and service sector inflation diffuses in the coming months, the logical basis for rate cuts will become more fragile. Second, the evolution of the Middle East situation—if the navigation issues in the Strait of Hormuz are not significantly alleviated in the short term and oil prices remain high or even continue to rise, the policy space for rate cuts will be compressed. Third, the internal political dynamics of the Federal Reserve—the widening divisions within the FOMC will significantly constrain Warsh's decision-making space.
The Federal Reserve will maintain high interest rates in the short term, and the focus of monetary policy is shifting from "when to cut rates" to "whether to raise rates again." For global asset pricing, the current situation involves increasing uncertainty. Lu Zhe stated that if the US-Israel-Iran conflict significantly eases in May–June and oil prices fall back to $80 per barrel, US inflation is expected to decline in the second half of the year, which could serve as an excuse for the new Federal Reserve Chair to cut rates for "political correctness" considerations.
Inflation is the economic shadow cast by the Middle East conflict, and shadows are often more enduring and elusive than the conflict itself. If the situation does not improve rapidly, Warsh may have to personally bury the prospects for rate cuts amid the inflation storm, even if it means going against the expectations of the White House.
Comments