The dollar ticked up slightly after the May CPI report confirmed the market's worst fears. Inflation in the US accelerated to 4.2% year-on-year — the highest since early 2023. On a monthly basis, prices rose 0.5%. Real average hourly earnings fell 0.7% year-on-year — the largest decline in over three years. All this suggests Americans are getting poorer against a backdrop of record-low consumer confidence.

More than half of the rise in headline CPI was driven by energy — gasoline jumped 7% month-on-month. That is understandable: a closed Strait of Hormuz, the war with Iran and elevated oil prices. However, the only bright spot in the report was the core measure: excluding food and energy, prices rose just 0.2% month-on-month — below forecasts. Food prices increased only 0.1%; beef, tomatoes and cheese actually fell. Transportation services, health insurance and new car prices also declined. This gives the Fed a formal argument for a pause — but only a formal one.

The problem is that even if the war ends quickly, inflationary pressure will not vanish. Economists warn of a wave of second-round effects: fertilizer market disruptions will ultimately push up food prices, higher transport costs will pass through the entire consumer-goods chain, and rebuilding oil inventories will take months. In other words, reopening the Strait of Hormuz would not bring rapid relief to household budgets.

This is an extremely awkward scenario for the Fed. The June 16–17 meeting — the first under Kevin Warsh's leadership — is highly likely to end in a pause given the geopolitical uncertainty. Yet markets are already pricing in a rate hike by year-end, and the May report has only reinforced that view.

Core inflation running below expectations gives Warsh room for caution, but headline CPI at 4.2% combined with falling real wages is a politically and economically toxic mix.

All of this suggests that, despite a modest pick-up in demand for risk assets, the US dollar is still likely to be in demand among large traders and market participants.