Viewpoint
June 12, 2026 | 14:02
Marinating in an Inflationary Stew
Economics
Economics
Economics
Economics
Economics
Economics
Marinating in an Inflationary Stew |
| Four months of war in the Persian Gulf and the closure of the Strait of Hormuz are taking a toll, swiftly pushing prices higher and reversing three years of progress on inflation. Producers and consumers once again find themselves marinating in an inflationary stew with no easy exit. The Administration’s new Section 301 ‘forced labor’ tariffs on 60 countries alongside additional tariff actions and investigations on the horizon only add more ingredients into this inflationary stew. |
| News on Thursday that an Iran deal may be imminent—potentially reopening the Strait, extending the ceasefire, lifting oil sanctions, and unfreezing some Iranian assets—helped push oil prices down sharply. Still, it will likely require sustained significant declines in energy prices to meaningfully alter this unfavorable inflationary outlook. This week’s data provided a fresh look at how energy inflation is already permeating more sectors of the economy, at both the producer and consumer levels. The May CPI report came in largely as expected but still troubling, rising 0.5% during the month and accelerating to 4.2% y/y (Chart 1). Energy prices were up 23% from a year ago, transportation costs rose nearly 9.0%, apparel prices increased almost 5.0%, while both housing and overall services climbed around 3.5%. Food prices rose 3.0% over the same period. Core CPI offered only modest relief, increasing 0.2% in May and 2.9% y/y. Even here, underlying inflation may be somewhat understated, temporarily held back by consumers’ growing sensitivity to higher prices and eroding purchasing power, as well as businesses’ reluctance to fully pass through rising costs for fear of losing customers. Producer prices, however, were the more concerning signal, rising 1.1% in May and matching April’s outsized gain. Absent a 1.1% decline in trade services, headline PPI would have surged 1.6% on the month. In short, producer prices are rising significantly faster than consumer prices, revealing further pipeline pressure that could eventually be filtered down to consumers even if the conflict with Iran is resolved in the near term. On a year-over-year basis, producer energy prices are up 36%, transportation and warehousing prices have jumped 14%, goods prices have risen 10%, and services prices have increased 4.9% (Chart 2). By stage of production, the data suggest we are still in the early innings of this pass-through. Early-stage crude goods prices through May have already jumped 22.4% from a year ago, compared with a 13.1% increase in intermediate goods and nearly 9% for finished goods (Chart 3). A similar pattern is evident in food prices: crude food and feedstuff inflation hit 4.3% y/y in May, while finished consumer food rose a smaller 2.4%. Investors nevertheless found some relief this week, with core CPI moderating from April’s pace, and more concrete signs of a potential Iran deal. That combination will likely be enough to keep the Fed on hold at next week’s FOMC meeting. However, it does little to eliminate the possibility of a rate hike later this year, with fed funds futures still pricing in around an 84% chance by year-end. Looking ahead, next week’s data may reveal the other ugly side of the inflation story. We expect a decline in core real retail sales for May, as more consumers struggle to keep up with a rapidly rising cost of living and are increasingly forced to trim discretionary spending. |
Fed Preview: Warsh Up |
| Kevin Warsh’s first FOMC confab as Chair is June 16-17. Among the upcoming policy pronouncements, we are expecting some major changes but not owing to Warsh. These were already starting to stir at the last get-together, with momentum mounting as the interim seven weeks unfolded. Having been sworn in only 3½ weeks before the meeting, it will be interesting to see how the new Fed head, with his reported predilection for lower policy rates, embraces the FOMC’s expected decision to drop the easing bias and signal that the next action could be a rate hike just as easily as a cut. Good-bye bias… At the last meeting, the Fed retained the phrase: “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.” Since rate cuts began in September 2024, including or not including “the extent and timing of” has been employed as forward guidance. When the wording has been absent, it has signaled a cut next meeting (Sept./Nov. 2024; Sept./Oct. 2025). Otherwise, it has signaled a cut as early as the next meeting (the past two Julys) or after a multi-month hold. The phrase is effectively an ‘easing bias’, and it became problematic for three FOMC voting members. Cleveland President Hammack, Minneapolis’ Kashkari, and Dallas’ Logan supported keeping policy rates unchanged “but did not support inclusion of an easing bias in the statement at this time.” Given the increased risk of faster inflation from the oil shock (with the labor market at least stabilizing in the background), they preferred a more neutral statement to convey that rate cuts were no more likely than hikes. The meeting’s Minutes revealed that “many” participants (not just the three voters) wanted to remove the easing bias. More profoundly, “a majority of participants highlighted, however, that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 percent.” Since then, we reckon the ranks of the ‘neutralists’ have increased (now including the influential Governor Waller) and likely crossed the seven-member threshold needed to change monetary policy. While Warsh is not a fan of forward guidance (“Unlike many of my colleagues past and present, I don’t believe in forward guidance… I don’t believe that I should be previewing for you what a future decision might be.”), we wonder how much of a fan he is of moving further away from rate cuts. Got dot plot… The FOMC is expected to keep policy rates unchanged, with the target range at 3.50%-to-3.75%, marking the fourth consecutive pause and signaling that the hold could last longer than before. In the Summary of Economic Projections (SEP) from March, the median forecast had a 25 bp rate cut by the end of this year and another one by the end of next year. We look for this pattern to be pushed back by a year, meaning a policy pause potentially persisting deep into 2027. And we would not be surprised if at least one participant pencils in a hike for this year. Given that he does not “believe” in forward guidance, Warsh would probably prefer to drop the dot plot. But it takes a majority in the Committee to make major changes to policy communications (note that there are other officials who are also not fans of the dot plot). We would not be surprised if Warsh opted not to provide his fed funds projection (like former St. Louis Fed President Bullard not providing his longer-run dot). Meet the press… The inaugural post-meeting press conference will be ‘must-see TV’. Warsh is going to have to walk a fine line between discussing his “regime change” agenda and the Committee’s policy consensus. Interestingly, he has been critical of too many Fed officials being quoted in the media and the regularity of the post-meeting presser (the latter being part of communications strategy), which could affect his interactions with reporters. Meantime, there will be many more questions for Warsh, including how things went with former Chair Powell still at the table. The June meeting will mark the start of Warsh’s efforts to effect change at the Fed. And it is going to be much more of an evolutionary process than a revolutionary one. |
