All eyes on the Fed's next move as US inflation jumps to 5% in May

US inflation jumped to 5% year-on-year in May from 4.2% in April, beating analysts’ expectations of a 4.7% increase, as the US economy continues its swift recovery from the shock of the pandemic.

Core inflation also increased to 3.8% year-on-year, more than the expected 3.5%, marking the fastest annual rate of increase since June 1992.

The surge in core inflation is in part due to the successful vaccine rollout in the US, which has allowed consumers to spend their savings - J.P. Morgan Asset Management estimates that US consumers will have accumulated excess savings amount to a "whopping 12% of GDP" by the middle of the year.

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Bond markets seemed to shrug off the latest news, with 10-year US treasury yields up only slightly from closing at 1.49% yesterday (9 June) to 1.515% at 9.35am on 10 June. The stockmarket, meanwhile, is on the rise in morning trading, with the S&P 500 opening 0.6% higher at 4,246 points.

Willem Sels, CIO, private banking and wealth management at HSBC, said the rise in headline CPI was to be expected, given the rising oil and commodity prices, and will likely peter out soon, perhaps as early as next month.

However, he added: "But the fact that core CPI also jumped more than expected indicates that there are factors besides oil and commodity prices at work, and that the outlook for inflation remains uncertain."

Fed's next move

Given the potentially more structural nature of this rise, then, all eyes will be on the Federal Reserve's reaction, experts predict.

According to Robert Alster, CIO at Close Brothers Asset Management: "We are likely to hear more calls for action to deter rising inflation from the hawkish side of the administration. Whether these calls are heeded, and we see monetary policy levers being pulled, will depend on the next few months of data."

So far, the Fed has taken a decidedly dovish stance, keeping interest rates and QE unchanged, and seemingly willing to let the economy run hot for some time. It remains to be seen what magnitude of price rises would sway its hand.

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For the time being, most experts predict the rise in inflation will be short-lived. Silvia Dall'Angelo, senior economist at the international business of Federated Hermes, explained that "cost-push price pressures are typically short-lived, if they are not accompanied by demand-pull prices pressures, i.e. higher wage inflation and/or higher long-term inflation expectations".

But while the recovering labour market is unlikely to be a source of sustained inflationary pressures, she warned the higher numbers themselves could affect inflation expectations if they persist.

However, Ambrose Crofton, global market strategist at J.P. Morgan Asset Management, believes the Fed will not make any rash decisions at its next meeting.

"We think that the Fed will continue to assess that this rise in inflation is transitory - indeed it's too soon for this hypothesis to be tested," he said.

"But we think that taper talk will now be introduced as the Fed questions whether it is still appropriate to be purchasing $120bn of assets per month at a time when the US economy is running hot."

According to Daniel Casali, chief investment strategist at Tilney Smith & Williamson, for the moment at least, "this macro backdrop remains favourable for equities over long-duration nominal bonds".