Macro Consensus Challenger: Inflation Keeps Surprising on Downside

Summary

• May CPI was again below expectations.
• The print shows no sign of second-round effects. Non-tariffed goods and services prices were aligned with or below trend.
• Therefore, I keep my expectations that inflation will peak at end-2025 and slow thereafter, in line with consensus.
• Three scenarios would falsify my view: a worsening of the trade war, an oil price shock, and a snapback of business and consumer confidence.

Market Implications

• I still expect two-three Fed cuts in 2025 starting at September’s FOMC, against markets pricing two cuts.

Another Negative CPI Surprise

May CPI was again below expectations (Table 1). For once I agree with the consensus. Inflation is likely to peak at end-2025 and fall in 2026. This is what the swap market is pricing and is also economists’ consensus (Chart 1).

Here, I analyse May’s CPI and find nothing changes my view. I also discuss how I (and consensus) could be wrong.

I estimate May’s average tariff was about 9%, against April’s 6% and February’s 2% (Chart 2). This is based on May’s customs revenues of $22bn, up from $16bn in April, and on my estimate of imports falling to about $250bn in May, as importers make up for the December-March import surge (Chart 3).

Yet, despite the tariff increase, the prices of core goods excluding used cars (largely not traded internationally) were virtually unchanged (Chart 4). The uptrend in core goods price inflation that started about a year ago, is slowing.

This reflects importers, wholesalers and retailers having partly eaten the tariff increase (Chart 5). Also, prices of non-tariffed goods like used cars remain stable (Chart 6).

Table 1: May CPI Below Expectations (MoM)

Chart 1: Unchanged Pricing of CPI After Data	Chart 2: Tariffs Rose Further in May
Chart 3: May Imports Likely Fell Further	Chart 4: Goods Inflation Flattens
Chart 5: Tariffs Getting Partly Absorbed	Chart 6: Used Car Prices Falling

OER Inflation Still Slowing

OER inflation slowed further MoM and YoY in May (Chart 5). OER inflation remains above market rent inflation, suggesting further downside (Chart 6).

Chart 7: OER Still Slowing	Chart 8: OER Could Have More Downside

Slower Supercore Inflation

Since end-2024, supercore inflation has slowed sharply partly due to a sharp fall in airfares (Chart 10). In May they fell by 2.7% MoM and are now 13% below their level of December 2024 (Chart 8). TSA data shows this is in response to lower passenger traffic (Chart 9).

Even medical services inflation, another key category of consumer spending, has been slowing (Chart 12).

Chart 9: Sharp Supercore Slowdown…	Chart 10: …Driven by Airfares
Chart 11: Travel Demand Is Falling	Chart 12: Medical Inflation Has Been Stable

Overall, data shows no signs that prices of services or non-tariffed goods is rising above trend. To the contrary, services inflation is slowing. We cannot yet see signs of second-round effects from tariffs. But it is still early days.

Stable Inflation Despite Tariffs

In sum, inflation remains lower than in January-February and stable despite the introduction of tariffs (Charts 13-15).

The most striking aspect of recent inflation prints is how they keep surprising on the downside (Chart 16). I think this reflects two broad factors:

• Exaggerated fears of a repeat of the 2021-22 inflation acceleration. These are shown, for instance, by decoupling of survey-based inflation expectations from market-based expectations and from wages (Chart 17).
• Underestimation of consumer demand weaknesses that limit firms pricing power and ability to pass on tariff increases (Chart 18).

I expect the public expectations to adapt and the surprises to become more balanced. By contrast, I expect the lack of second-round effects from tariffs to persist.

Chart 13: Core CPI Lower Than in January-February	Chart 14: CPI Alternatives Lower Too
Chart 15: Core PCE Near Fed Target	Chart 16: Negative Inflation Surprises
Chart 17: Public Fears Tariffs	Chart 18: Weak Confidence

How I Could Be Wrong

Three scenarios could falsify my views.

First, a worsening of the trade war that would cause much higher tariffs and/or a de facto embargo on imports. That was the situation prevailing before last month’s US-China deal. Without the deal the US would have experienced goods shortages and much higher inflation. Such a scenario is not likely as it would be politically and economically unsustainable.

Second, an oil shock, for instance due to a worsening of geopolitics in the Middle East. In such a scenario, a surge in energy prices could lift inflation expectations, actual inflation and possibly trigger a wage-price feedback loop. I expect the Trump administration would try avoiding such an instance because of its economic and political costs.

Third, a snap back of private confidence and spending. Policy uncertainty has weakened private sector confidence with consumers and businesses postponing expenditures. Should confidence return, private spending would accelerate, businesses’ pricing power would improve and the passthrough from the tariffs would grow. Such a scenario would require a deep change in the administration’s policymaking style that does not currently seem likely.

Market Consequences

I still expect two-three Fed cuts in 2025 starting at September’s FOMC, against markets pricing two cuts post May’s CPI.

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