Core CPI cools to 0.2% in May but Treasury yields climb to 4.54%

U.S. core consumer prices rose 0.2% in May, below the 0.3% consensus, yet the 10-year yield climbed 2.4 bps to 4.54% as oil surged above $97 on Iran tensions.

"We do have this obvious push from energy inflation that's increasing the headline numbers and pushing us further away from target," Thomas Simons, chief U.S. economist at Jefferies, said. "But on the other side, there is a pretty steep decline in energy prices that's eventually going to come."

The 2-year note yield, more sensitive to Fed policy expectations, rose 0.85 bps to 4.1266%, while the 30-year bond yield added 2.84 bps to 5.0241%. The 2/10 spread widened 1.5 bps to 41.2 bps. Real yields also jumped, with the 2-year TIPS rate surging 4.8 bps to 1.5863%, the highest level in over a year, signaling markets are repricing for tighter monetary policy. Brent crude rose 4.3% to $97.14 a barrel after Israel and Iran exchanged missile strikes for the first time since the April ceasefire.

The data keeps the Fed on track to hold rates at 350-375 bps at its June 17 meeting — swaps price a 98% probability of no change — but the combination of sticky headline inflation and energy-driven supply shocks has boosted the odds of a hike by December to 68%, according to CME FedWatch. If oil prices sustain above $100, core inflation could reaccelerate, delaying any easing into 2027.

The May CPI report showed headline inflation rising 0.5% month over month, in line with forecasts, and 4.2% from a year earlier, accelerating from April's 3.8% pace. Core inflation rose 2.9% year over year, matching estimates. The core monthly reading of 0.2% was the softest since February, offering some relief after three months of upside surprises. Shelter costs, which account for roughly a third of the CPI basket, rose 0.4% month over month, moderating from the 0.5% pace in April.

The labor market adds another layer of complexity. Nonfarm payrolls rose 172,000 in May, above the consensus estimate, while the unemployment rate held at 4.3%. The resilience gives the Fed room to keep rates elevated even as inflation moderates. President Donald Trump said Fed Chair Kevin Warsh should "do whatever he wants" on rates but added that raising borrowing costs would "kill success" after what he called a "great" jobs report.

Oil and geopolitics

The jump in energy prices introduces a wild card. Brent crude surged above $97 for the first time since October after Israel and Iran traded missile strikes, breaking the April ceasefire. Each $10 sustained increase in oil adds roughly 0.3 percentage points to headline CPI, according to Jefferies estimates, threatening to keep inflation above the Fed's 2% target through year-end. The last time the 30-year yield traded above 5% was in late 2023, when the Fed's tightening cycle pushed long-duration yields to multi-decade highs before a subsequent rally brought them back down.

The Treasury will test demand for $119 billion in new coupon-bearing supply this week, including $58 billion in three-year notes Tuesday, $39 billion in 10-year notes Wednesday and $22 billion in 30-year bonds Thursday. The 10-year auction will be the first since the yield breached 4.50%, a level that has historically attracted buyers. The 30-year bond auction on Thursday will be closely watched as a gauge of long-term investor appetite at yields above 5%.

Simons expects consumer price inflation to fall back below 2% within a year as this year's energy-driven spikes make next year's comparisons easier. But for now, the market is pricing a higher-for-longer scenario: the 30-year yield above 5% signals that long-duration investors demand a premium for inflation and geopolitical risk. The S&P 500 fell 0.6% in afternoon trading as rising bond yields pressured equity valuations, while the dollar index gained 0.3% against a basket of major currencies.

This article is for informational purposes only and does not constitute investment advice.