CICC has released a research report stating that US CPI for May rose 0.5% month-on-month on a seasonally adjusted basis and 4.2% year-on-year, marking the highest level of increase since 2023. Core CPI increased 0.2% month-on-month and 2.9% year-on-year. This inflationary uptick was primarily driven by the energy component, with gasoline and fuel oil leading the gains. Spillover effects from the energy rise continued to manifest in areas like airfares and courier services but have not yet become widespread.
Core inflation remains generally moderate. Demand in oil-sensitive sectors such as automobiles has been squeezed, and the pace of rent increases has also narrowed significantly. The current inflation is still dominated by structural factors like energy shocks, with cyclical inflation not yet evident. However, risks associated with a rebound in aggregate demand from expanding AI capital expenditure and improving labor conditions warrant vigilance.
Regarding monetary policy, CICC maintains its baseline judgment that the Federal Reserve will neither cut nor raise interest rates within the year. It is anticipated that the Fed's stance will remain hawkish. Upon taking office, Chair Powell's primary task will be to rebuild policy credibility. He is more likely to demonstrate resolve by reinforcing expectations for balance sheet reduction (quantitative tightening) rather than hinting at rate hikes.
A scenario of "balance sheet reduction first, rate cuts delayed" cannot be ruled out. This combination would exert sustained pressure on assets fundamentally at odds with Powell's monetary philosophy, those that are liquidity-driven and benefit from excessive US dollar issuance. CICC's main views are outlined below.
The primary driver of the recent US inflation increase is the energy component. Seasonally adjusted energy prices rose 3.9% month-on-month in May, with gasoline and fuel oil prices increasing by 7% and 3.8% respectively, while natural gas prices fell slightly by 0.5%. Concurrently, secondary pass-through effects from higher energy prices are still being observed but have not spread widely. Airfare rose 2.7% month-on-month, and postal and courier service prices surged 5.2%, marking the third consecutive month of increases for both. Food prices rose 0.2% month-on-month, a deceleration from the 0.5% increase seen in April.
Looking ahead, there are no substantial signs of easing in the Middle East situation, and the Strait of Hormuz remains closed. The pattern of elevated energy prices is likely to persist.
Core inflation is generally moderate, partly because high energy prices are squeezing consumer demand. This is most prominent in the oil-sensitive automotive sector: new car prices fell 0.3% month-on-month in May, used car prices edged up 0.1%, motor vehicle insurance prices declined 1.7%, and car and truck rental prices dropped significantly by 4.2%, indicating an overall weak trend.
Within services, rent prices increased 0.3%, a notable slowdown from the 0.6% rise in April. One reason is that April's rent figure experienced a one-time statistical jump. Based on leading indicators for rents, future rent inflation is likely to remain moderate and is unlikely to become a primary driver of inflation.
Core services inflation excluding rent is generally mild. Medical care service prices rose 0.5%, primarily driven by dental services (up 1.9%). Transportation service prices fell 0.6% month-on-month, as the weakness in motor vehicle insurance and car rental prices, mentioned earlier, offset the continued strength in airfares.
Overall, current US inflationary pressures remain predominantly structural, with cyclical inflation not yet prominent. Energy shocks, price increases in some services, and supply-demand mismatches in electronics driven by the AI wave constitute the main variables, but they have not yet triggered a broad-based price surge similar to 2021-2022.
However, the potential for a rebound in aggregate demand and its inflationary impact requires attention going forward. Since the beginning of the year, sustained expansion in US AI capital expenditure has significantly boosted upstream industry sentiment. Simultaneously, improving employment trends have enhanced economic resilience. Against this backdrop, a re-emergence of cyclical inflation cannot be ruled out. If corporate pricing power and household consumption resilience persist simultaneously, inflation stickiness could become stronger than in a scenario driven solely by energy shocks.
On monetary policy, CICC maintains its baseline forecast from its mid-term outlook report that the Fed will neither cut nor raise rates this year. With headline inflation exceeding 4%, double its 2% policy target, this will reinforce the Fed's decision to forgo rate cuts this year. However, this inflation report alone is unlikely to prompt the Fed to pivot swiftly towards rate hikes because inflationary pressures are currently still structural, core inflation remains moderate, and there are no signs of the economy overheating comprehensively.
Meanwhile, the Fed's attitude is expected to remain hawkish, and a dovish turn is unlikely even under Chair Powell's leadership. After suffering credibility costs in 2021 for underestimating inflation and allowing monetary policy to fall behind the curve, the Fed is highly unlikely to casually label this round of inflation as "transitory" again. With the labor market largely stabilized, the focus of monetary policy in the second half of the year will return to inflation.
The Fed needs more time to observe whether inflationary pressures are confined to energy shocks or will evolve further into demand-driven cyclical inflation fueled by AI-related demand. Faced with elevated inflation, Chair Powell's primary task upon taking office will be to establish policy credibility. This is expected to lead him to voice concerns about inflation to demonstrate his commitment to price stability.
There are typically two paths to demonstrate such resolve. The first is to hint that rate hikes are not off the table if necessary. However, it is judged that Powell would not favor this approach as it contradicts his policy advocacy of "balance sheet reduction + rate cuts." The second path is to adopt a hawkish stance on balance sheet policy, reinforcing expectations for quantitative tightening. The latter is more probable, as it also aligns with his long-held monetarist belief that inflation is always and everywhere a monetary phenomenon.
Consequently, a scenario of "balance sheet reduction first, rate cuts delayed" cannot be ruled out. This specific policy mix would precisely exert sustained pressure on assets that are purely reliant on liquidity drivers and benefit from excessive dollar issuance. Fundamentally, these assets are incompatible with Powell's monetary philosophy, which is the primary reason for their recent underperformance.
CICC reiterates its previous view: Powell's appointment may represent a significant watershed in the Fed's policy framework, marking the end of the era of massive monetary stimulus, with profound implications for the macroeconomy and financial markets.
Comments