May’s CPI Reminds Us “It Takes Two to Tango”
Drop in aggregate demand can offset supply shock of higher tariffs …
Just as it takes two to tango, prices are not set solely by cost by supply cost or tariffs alone. Demand also plays an important role. May’s lower-than-expected CPI can be ascribed to consumer resistance to higher prices or a drop in demand.
The aggregate demand curve for consumer products has been driven lower by a soft labor market. Many misinterpreted May’s slightly higher-than-expected addition of 139,000 jobs to payrolls.
May's increase in payrolls was badly lopsided. After accounting for the addition of 126,000 jobs to health care, social assistance, leisure, and hospitality, the remainder of payrolls showed (i) an addition of only 14,000 jobs to the rest of private sector payrolls and (ii) a loss of -1,000 government jobs.
Unlike May’s 0.31% monthly advance for the sum of the jobs found in healthcare, social work, leisure, and hospitality, the remainder of May's payrolls barely rose by 0.01% from April. Had May's overall estimate of payrolls edged up by an imperceptible 0.01% from April, May's increase in payrolls would have been a tiny 17,000 jobs. Often, the latter indicates the nearness of a recession.
Notwithstanding May’s lower-than-expected CPI both with and excluding food and energy prices, the 10-year Treasury yield had dropped no lower than 4.42% in late afternoon trading. The credit market still fears the inflationary potential of higher tariffs.
Tariff-vulnerable apparel prices drop for second straight month …
Thus far, tariffs have not had a material impact on the consumer price index. Many were braced for a tariff induced jump by apparel prices in May, if only because much apparel comes from abroad. To the contrary, after declining by -0.2% from the prior month in April, apparel prices fell by another 0.4% in May. Over the three-months- ended May, apparel prices deflated at an annual rate of -1.0%.
Tariff-driven price hikes on new vehicles may sink unit auto sales …
Imports of both motor vehicle parts and fully assembled vehicles figure prominently in U.S. sales of cars and light trucks. To avoid an expected summertime arrival of tariff-driven price hikes, consumers went on a motor vehicle buying binge during March and April.
Compared to the average annualized sales pace of 16.2-million units during the six months ended February 2025, the annualized sales pace jumped up to 17.8 million units in March and 17.3 million units in April. However, unit sales plunged by -9.3% from April to May to a 15.6-million-unit annualized pace.
Despite all the hullabaloo over tariffs and the jump in motor vehicle purchases during March and April, new vehicle prices barely rose by 0.1% from February to April. More recently, May’s plunge by unit sales of light motor vehicles helps to explain why the prices of new vehicles sank by -0.3% from April.
Coincidentally, May’s deep drop by unit sales of cars and light trucks favors a monthly decline by May’s real consumer spending following monthly gains of 0.1% in April and 0.7% in March.
Early June’s Blue Chip survey disputes talk of 3% to 4% real GDP growth …
The just released Blue Chip survey of early June contains a consensus forecast of a 1.7% annualized first- to second-quarter increase by US real consumer spending. Thereafter, the same consensus projects a 0.6% annualized uptick by real consumer spending from 2025’s second- to fourth-quarter. The Blue Chip consensus also foresees a meager 0.6% annualized rise by real GDP from 2025’s second- to fourth-quarter.
The consensus forecasts for 2025’s second half mask an atypically wide divergence between the highest and lowest forecasts. Blue Chip’s top 10 forecasts call for second to fourth quarter annualized growth rates of 1.7% for real consumer spending and 1.8% for real GDP, while the bottom 10 projections call for comparably measured annualized contractions of -0.7% for real consumer spending and -1.0% for real GDP.
The gaps between the top 10 and bottom 10 Blue Chip forecasts are very wide from a historical perspective, which reflects the elevated uncertainties now facing businesses and consumers. A good deal of planned spending and hiring will be put on hold until tariff issues are resolved. And the longer tariff unknowns persist; business activity will be slower than otherwise.
Talk of recurring 3% to 4% real economic growth following the resolution of tariff issues is strongly disputed by almost all professional prognosticators. After government spending driven advances by US real GDP of 2.9% in 2023 and 2.8% in 2024, the Blue Chip consensus projects a yearlong annual growth rate of 1.4% for both 2025 and 2026. Of the 48 contributors to the Blue Chip survey, the highest predicted real GDP growth rates were 2.2% for 2025 and 2.3% for 2026.
Early June’s Blue Chip consensus also predicts a jump by annual rate of CPI inflation from May’s 2.4% to a 3.3% average for 2025’s final quarter. However, consumer resistance to tariff-induced price hikes may prevent the latter forecast from being realized.
CPI’s readings on property and health insurance inflation look suspect …
I find it hard to believe in the accuracy of May’s 2.9% year-on-year increases for both (i) tenants’ and household insurance and (ii) health insurance according to the CPI. Nevertheless, May’s annual rates of consumer price inflation of 0.3% for medical care commodities and 3.0% for medical care services suggest my impression of healthcare insurance running well above 2.9% may be wrong.
Still, medical care prices may soon rise at a faster pace given the current squeezing of healthcare company profit margins by fast rising costs. Regulation cannot rein in prices indefinitely without risking a diminution of product quality.
Under the heading of medical care commodities, May’s CPI reported a 0.8% annual rate of inflation for prescription drug prices and annual rates of price deflation of -0.6% for over-the-counter drugs and -0.2% for medical equipment and supplies.
I’m still struck by the fact that during the 10-years-ended May 2025, the 2.6% average annualized rate of medical care inflation lagged the comparably measured 3.1% rate shared by the CPI and core CPI.
VIX takes its cue from below-average high-yield bond spread and declines …
Unsustainable imbalances offer a useful starting point when making forecasts. In reaction to tariff-related risks, the pricing of corporate credit failed to mimic the high anxiety shown by common equity shares.
Consider the vastly different responses to tariffs by the VIX metric of equity market risk and the high-yield bond spread proxy for credit market risk. In reaction to tariff fears, the VIX's five day moving average peaked at the 43.8 points of the span ended April 10 2025. The latter was far above the VIX's long-term median of 16.8 points.
It was also during the five-days-ended April 10 that the composite high yield bond spread peaked at 452 basis points. However, the high yield bond spread’s peak five trading day average wasn't much greater than its corresponding long-term median of 434 basis points.
With the relatively high correlation of 0.80 between the equity market’s VIX and the corporate credit market’s high yield bonds spread, the VIX and high yield bond spread ordinarily do not diverge from each other for long. Whenever the two diverge, one measure has got to give.
Since the profound imbalance between the risk measures during the five days ended April 10, the VIX has been approaching the high yield bond spread. In turn, the S&P 500’s five-day-moving average soared higher by 15.9% from April 10, 2025 to June 10.
The high-yield bond spread recognized early on how the latest bout of tariff-driven anxiety over prospects for corporate earnings was not the product of a tangible worsening of fundamentals. Rather, tariff-related risks are the offshoot of the decisions of a single individual, namely the president of the United States. Unlike COVID, if the economic outlook deteriorates materially, the president has the power to immediately take corrective action regarding tariff policy.
Because the damage resulting from tariff risks is of recent vintage and self-inflicted, a correction of harmful tariff policies may prompt a quick improvement in the corporate earnings outlook. Once Trump is pushed up against the wall by a faltering economy, the corporate credit market believes Trump will respond with a quick resolution of tariff-related issues.
