US Inflation Likely To Hit 3-Year High In May, RBC Says: ‘Bad News For Consumers, Good News For Labor Market’

• Higher energy prices will push headline inflation higher, according to RBC economists.
• The research arm of the bank expects core CPI, which excludes volatile food and energy prices, to rise 0.3% month-over-month in May. 
• While higher inflation would pressure consumers, RBC said that businesses appear to have enough pricing power to preserve profit margins, reducing the likelihood of widespread layoffs.

U.S. consumer inflation is on track to accelerate to its highest level in three years amid rising energy and food prices, according to RBC Economics.

The Consumer Price Index (CPI) for May will be released by the Bureau of Labor Statistics (BLS) on Wednesday and the research and forecasting division of the Royal Bank of Canada (RY) does not expect “that it will be a reassuring development.”

RBC Economics expects headline inflation to increase by 0.5% month-over-month in May, bringing the year-over-year pace to 4.2%.

"Higher energy prices continue to push headline inflation up," economists wrote in a note. "And we do not expect to see a meaningful reprieve in the food space either, especially following recent headlines about beef prices."

RBC’s Rationale On Inflation

The research arm of the bank expects core CPI, which excludes volatile food and energy prices, to rise 0.3% month-over-month in May. That would push annual core inflation to 2.9%, higher than the Fed's 2% inflation target, it said.

“Higher jet fuel prices will continue to add to core services, while tight labor markets which keep a floor under wage growth are limiting core services disinflation,” the economists said.

“And core goods inflation has been helped in recent months by new and used car prices, which are masking price pressures for trade-exposed products like apparel, personal care products, and motor vehicle parts.”

RBC Economics noted that recent ISM manufacturing and services surveys showed that companies are increasingly willing to pass those costs on to consumers.

RBC expects Producer Price Index (PPI) data to reflect those trends. The bank forecasts headline and core PPI to rise 0.6% in May, lifting annual producer inflation to 6.3% and 5.5%, respectively.

While higher inflation would pressure consumers, RBC said that businesses appear to have enough pricing power to preserve profit margins, reducing the likelihood of widespread layoffs.

"This is bad news for consumers but good news for the labor market," RBC said. The forecast comes on the heels of a strong May jobs report. The U.S. economy added 172,000 jobs last month, while the unemployment rate held steady at 4.3%.

“And the May jobs report showed net new job creation continued (to the tune of 172K). An unemployment rate that is stable at exceptionally low levels (4.3%) is reassuring, but a stable job market will come at the expense of consumer budgets,” the bank said.

Market Reaction To Jobs Data

The stronger-than-expected labor market data sent Treasury yields sharply higher on Friday. The benchmark 10-year Treasury yield climbed above 4.5% and was around 4.57% at the time of writing.

White House National Economic Council Director Kevin Hassett said last week that the robust labor market gives the Federal Reserve room to remain patient. "It's a supply-side driven job market boom, which I think means the Fed can watch the inflation numbers and wait a while before it does anything about it," Hassett reportedly told CNBC.

Meanwhile, U.S. equities edged higher in the overnight session, heading into Monday. The SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index, was up 0.39% at the time of writing amid ‘bullish’ retail sentiment.

The Invesco QQQ Trust ETF (QQQ) was up nearly 1%, and the SPDR Dow Jones Industrial Average ETF Trust (DIA) declined 0.34%. Meanwhile, the iShares 20+ Year Treasury Bond ETF (TLT) fell 0.27% overnight amid ‘neutral’ retail sentiment.

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