May CPI Preview: Inflation Set for Modest Rebound as Tariffs, Base Effects Cloud Fed’s Path Forward

Markets are bracing for a potentially pivotal May Consumer Price Index (CPI) report on Wednesday, as investors assess whether inflation is staging a re-acceleration just as the Federal Reserve contemplates its next move. Headline and core inflation are both expected to tick modestly higher on a year-over-year basis, though underlying dynamics remain complicated by tariff volatility, sticky categories, and base effect distortions. As the Fed’s June decision looms, traders are hoping for confirmation that disinflation remains intact—though the path forward may get bumpier before it gets smoother.

Economists expect headline CPI to rise 0.2% month-over-month in May, matching April’s pace. Year-over-year, headline inflation is seen climbing to 2.5% from 2.3%, driven largely by base effects as unusually soft readings from May and June 2024 drop out of the calculation. Core CPI, which excludes food and energy, is forecast to rise 0.3% MoM, pushing the annual rate up to 2.9% from 2.8%. Goldman Sachs sees a slightly softer core reading at +0.25% MoM and 2.89% YoY, while Bank of America projects +0.24% MoM and a modest YoY bump to 2.9%.

The headline figures, however, may belie growing upward pressure from recently imposed tariffs. While April’s trade actions have only begun to filter through supply chains, economists expect that inflationary effects will become more pronounced in the coming months. Categories most sensitive to Chinese imports—apparel, recreational goods, and select tech hardware—will be watched closely for signs of pass-through pricing. Although the Trump administration and Beijing announced temporary tariff reductions (cutting rates from triple-digit levels to around 30% and 10%, respectively), inventories stocked before April's escalation may insulate May’s reading, with a more noticeable impact expected in June and July.

Another factor that could obscure the inflation narrative is sticky inflation—price growth in categories that tend to be less volatile and more persistent. Core services excluding housing, often called “supercore” inflation, rebounded from a historically weak March reading (-0.24%) and is expected to average around +0.21% MoM in May. Services inflation remains particularly sensitive to wage trends and labor costs, and its trajectory will be critical to gauging whether inflation is sustainably converging toward the Fed’s 2% target. Notably, rental inflation—long a driver of core CPI—is forecast to remain moderate around +0.3% MoM after accelerating slightly in March.

Base effects are likely to complicate interpretation of this month’s data. The YoY CPI comparison is about to lap a period of unusually soft readings from May and June 2024, when inflation printed 0.0% and -0.1% MoM, respectively. Even a modest monthly increase of 0.1% to 0.2% in the current environment would result in a mechanical increase in annual inflation—making the next two reports look hotter than they truly are. This technical quirk is well understood at the Fed, but it could nevertheless stir volatility in markets and public discourse. Policymakers may be cautious about signaling rate cuts in an environment where inflation appears to be rising—even if the increase is statistical noise.

Supporting the base effect thesis is a warning from business surveys. Both the ISM and S&P Global PMIs have recently pointed to pricing pressure across key sectors. The ISM manufacturing Prices Paid index has surged in recent months, suggesting firms are paying more for inputs across supply chains. Meanwhile, the S&P Global PMI for April showed “steep increases” in input and output costs in manufacturing, and a surprise uptick in service sector pricing despite signs of weakening demand. The implication: Even if consumer-facing inflation stays tame for another month or two, the upstream pipeline may be primed for another round of price increases.

Against this backdrop, traders are increasingly skeptical of near-term Fed easing. Futures markets are assigning virtually no probability to a rate cut in June, and only a one-in-six chance of a July cut. A rate reduction is fully priced in by September, but even that could shift depending on how CPI and other inflation gauges evolve over the summer. Fed officials have emphasized that they are waiting for greater confidence that inflation is on a sustainable path lower—a bar that may get harder to clear if CPI accelerates on both technical and tariff-induced grounds.

Finally, while the Federal Reserve’s preferred measure—core PCE inflation—offers a broader view and tends to run cooler than CPI, the latter remains the first major data point each month and often shapes narrative and positioning. With the economy showing signs of slowing—particularly in consumer spending and housing activity—an upside inflation surprise could worsen fears of stagflation, complicating the Fed’s ability to thread the policy needle.

All told, Wednesday’s CPI report is unlikely to be a game-changer by itself, but it will mark the start of a critical two-month window where inflation is almost guaranteed to look worse before it gets better. Investors, economists, and policymakers alike will need to look past the noisy year-over-year optics and focus on the monthly core trend, especially in services and tariff-sensitive goods. Anything hotter than consensus may rattle markets and push rate cut bets further into the fall. Anything cooler, and it could validate the “calm before the storm” thesis. Either way, summer inflation prints are set to be anything but boring.