Stocks moved higher again on Tuesday morning, and a big part of the reason for the renewed optimism on Wall Street came from the latest report on the Consumer Price Index (CPI). Many news outlets touted the lowest year-over-year inflation rate in over two years, seemingly sounding the all-clear for a new bull market to establish itself fully.
Bullish investors might well get a prolonged upward move in stock indexes, but it won't be because inflation has ceased to be a problem. Indeed, it doesn't take much digging into the May CPI data to see troubling signs of persistent inflationary pressures that could take a long time to settle out. And with the Federal Reserve's monetary policy group weighing what to do about interest rates during the two-day meeting that began Tuesday, there's a lot riding on which aspects of the latest report policymakers focus their emphasis on.
The bullish case for CPI
It's easy to understand why a brief glance at the latest CPI report would make investors feel better. The seasonally adjusted CPI rose by just 0.1% month over month in May, down from a 0.4% rise in April. That brought the year-over-year rise in the CPI to 4%. That was its lowest annual rise since March 2021.
Some of the most important items in the CPI were among the best-behaved. Food prices were up 0.2% from April, their first increase in three months after a couple of flat readings. Meanwhile, the driving force behind the lower inflation rate was energy, with the index of energy prices falling 3.6% during the month of May. Gasoline prices fell 5.6%, while heating oil plunged by an even steeper 7.7%. Drops in electricity and natural gas utility prices were also beneficial for consumers.
Indeed, energy's influence over the past year has been crucial in bringing overall inflation down. Gasoline prices are down almost 20% from 12 months ago, while heating oil has fallen 37%. Despite geopolitical issues centering on Russia's invasion of Ukraine, crude oil prices are at some of their lowest levels in nearly two years.
Focusing on the core
Yet there are still plenty of reasons to be fearful of inflation. Removing the volatile food and energy portions of the CPI, the "core" index was up 0.4% in May. That brought its year-over-year gain to 5.3%, which is well above the 4% rise for the broader index and further still above the Federal Reserve's 2% inflation target.
Among the areas of greater concern, you'll find:
- Transportation services prices, which rose 0.8% for the month, are 10.2% higher than they were 12 months ago.
- Shelter costs, which rose 0.6% in May, are up 8% since May 2022.
- Used vehicle prices, which rose by 4.4% in May for the second month in a row, reversing some of their declines from the fall and winter months.
Although prices of goods have generally stayed more under control, services prices continue to rise at a 6.6% annual clip.
Will the Fed try to spoil the market's party?
Bullish market watchers believe that the low headline inflation rate will lead the Fed to stop raising benchmark interest rates, at least temporarily. That outlook is helping to support higher stock prices.
Yet one unanswered question is whether the Fed will see market sentiment itself as a contrary indicator. The more willing stock investors are to bid up share prices, the bearish argument would go, the less the Fed has succeeded in reining in speculative behavior. That, in turn, could prompt the central bank to take more aggressive action rather than pause its federal funds rate hikes.
Again, it's entirely possible that a new bull market has begun and will run higher. But investors would be well advised to consider the possibility that things won't work out as expected here. A prudent long-term investing strategy takes both factors into account.