US May CPI Looms: Wall Street Tense, Bond Market Bets on Year-End Rate Hike

Global financial markets are on edge as they await the U.S. May Consumer Price Index (CPI) report, with expectations of a significant jump in inflation.

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It is very difficult for the Fed to justify a rate cut in the current situation.

Analysts forecast the May CPI to reach 4.2% year-on-year, a notable increase from April's 3.8% and the highest rate seen since April 2023. This surge is primarily attributed to soaring gasoline prices, exacerbated by the conflict in Iran and potential disruptions in the Strait of Hormuz.

The core CPI, excluding volatile food and energy prices, is also projected to rise to 2.9% from 2.8%, marking its highest level since September of the previous year. This persistent inflation is shifting market sentiment away from anticipated interest rate cuts.

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The risks are tilted toward more persistent inflation and fewer rate cuts, or even rate hikes.

While the Federal Reserve is widely expected to maintain its current benchmark interest rate, the bond market is increasingly factoring in the possibility of a rate hike by the end of the year. This sentiment is reflected in the SOFR options market, where bets on a rate increase have surged. Economists, by a significant margin, now anticipate rates will remain unchanged for the rest of the year, a stark contrast to sentiments just a month prior.

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The optimistic scenario has virtually disappeared.

Market participants are closely monitoring the CPI data, as it could significantly influence market direction. Higher-than-expected inflation might lead to further increases in bond yields and pressure on the New York stock market, particularly affecting high-flying tech and AI chip stocks. Conversely, a lower-than-expected CPI could trigger a rally in bonds and stocks. However, the prevailing market scenario leans towards a prolonged period of stable, higher interest rates.

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Bonds are now approaching the most attractive valuations in years.