May CPI: Below expectations, increasing the probability of interest rate cuts

Key points

The expected issue of rising overall service prices (labor costs) due to the expulsion of immigrants has not occurred; instead, service prices have decreased due to weakened overall demand and employment.

▪️The prices of goods have not been significantly affected by tariffs. Considering the behavior of merchants stockpiling imports before the tariff war began in April, U.S. merchants expect their inventory to last until the fourth quarter, which means the impact on inflation will also be delayed until the fourth quarter. However, currently, the pressure seems to be smaller than expected.

▪️The Federal Reserve is in a position to lower interest rates, as monetary policy transmission has a time lag. It does not wait until the CPI falls back to the standard target of 2% to adjust its policy. Instead, it takes preventive measures by lowering interest rates in advance upon seeing signs of inflation decline and economic slowdown, to avoid greater economic costs caused by a lagged response.

Current real interest rates are relatively high, while the Federal Reserve had been cautiously observing due to uncertainties surrounding tariffs. After the tariff de-escalation, the policy constraints have significantly eased, which actually increases the likelihood of the Federal Reserve initiating interest rate cuts within the year.

The easing of tariffs combined with potential interest rate cuts can jointly alleviate the current macroeconomic pressures in the United States, boost interest rate-sensitive sectors such as real estate and cyclical stocks, and reduce the risk of the economy falling into recession.