US inflation is being driven disproportionately by energy, but other items are accelerating

Signs of a short-term inflation acceleration are putting pressure on the Fed to hike faster

Higher inflation puts pressure on the US Federal Reserve to tighten more aggressively, meaning borrowing costs will rise higher and faster than previously anticipated. Markets now expect 4% Fed funds rates by mid-2023. Review capital spending plans, especially those of long duration with high frontloaded costs.

With the window for a soft landing narrowing, firms should begin building recession scenarios into their planning. Pivoting out of mid-range price points into budget or luxury offerings could help capture demand in price-sensitive or income-constrained environments. On the B2B side, clients downstream from consumer staple sectors may offer a more resilient source of business.


After inflation appeared to slow in April, May data delivered a surprise—consumer prices rose 0.97% MOM, almost as fast as during the initial impacts of the Ukraine invasion in March.

The expenditure categories with the highest price increases were all in energy. Prices for fuel oil rose 16.9% MOM, while gas utilities were up 8% MOM (30.2% YOY), driven by a surge in European LNG demand. Air fares (up 12.6% MOM) were squeezed by high jet fuel costs combined with rebounding air travel demand. On the supply side, rising energy prices have been driven partly by underinvestment in refinery capacity, which has compounded the effects of the shortfall in Russian exports. Food, also hit by Ukraine war dislocations, was another major driver, adding 0.16% to the MOM figure.

However, May’s inflation was not driven solely by external factors. Rising trimmed mean CPI inflation, now at 9.6% YOY, shows inflation is broadening into more items. Even excluding food and energy, prices rose at 0.63% MOM, the highest since the reopening boom last summer. Rent, driven by the rapid wage gains of the last year, contributed more than a quarter of that.

IT goods, by contrast, continued to be a relative bright spot. Smartphone prices fell 5% MOM, down almost 20% YOY, as easing supply chain stress reduced input costs.

Our View

May’s CPI data has already driven a deterioration in market sentiment and financial conditions, as markets price in expectations of more punishing rate hikes by the Federal Reserve. While the May CPI report is sobering, underlying data points to mixed trends in the US inflation outlook. While Ukraine war dislocations are likely to continue pushing prices upward in Q3 2022, other signs point to easing supply chain pressures that together could allow for headline inflation to stabilize.

The key drivers of high US inflation in May (Ukraine war energy dislocations and rebounding air travel demand) are mostly temporary and likely to roll off in the coming months. Furthermore, the excess inventories built up by retailers in Q1/Q2 are prompting a shift to discounting in June. As a second order effect, retail overstocking is creating slack in logistics, as retailers use up existing stock before placing new orders. This adds to the general likelihood that supply chain woes will ease. Goods deflation, though not yet widespread, has been concentrated in systemically important items, such as semiconductors, causing an easing in auto production bottlenecks.

Nevertheless, given the unprecedented situation we are in, the range of possible inflation paths ahead is extremely wide. We might not yet have reached the peak. Lost Russian exports of metals and noble gases could still create bottlenecks in manufactured goods further down the line, as could China’s lockdowns. Energy prices could rise further. Inflationary psychology could take off more substantially, with US$ 2.6 trillion of excess stimulus cash fueling a demand-pull element that becomes hard to contain. In short, while some signs of easing prices could reduce pressure on the Fed later this year, it remains highly uncertain which effects will dominate.

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