U.S. CPI for May came in lower than expected, quelling market fears of immediate tariff-driven inflation. So, what’s really happening beneath the surface?

The most important factor is the inventory effect. Businesses—especially retailers, distributors, and importers—typically hold inventories that cover 4 to 8 weeks or longer. These inventories were purchased before the new tariffs took effect, meaning their costs do not include the newly imposed duties. As a result, the sale of this “low-cost, pre-tariff stock” does not immediately push prices higher. In the month tariffs are implemented—or even the next month—goods sold still reflect old pricing, and thus, CPI doesn’t spike right away.

In fact, the full price transmission chain may take several months to appear in the CPI.

In addition to inventory effects, many goods had already been ordered and were in transit before the tariffs kicked in. These “in-transit” items had locked-in costs. Also, importers and overseas manufacturers often have long-term supply contracts with fixed prices, requiring renegotiation or adjustment only in the next contract cycle to reflect the added tariff costs.

In short, tariff-driven inflation is real—but not immediate. In the first month, due to inventory, contract terms, and businesses absorbing costs, CPI rarely shows a sharp jump.

If future trade negotiations fail to remove tariffs (which seems likely), their delayed impact could gradually surface in CPI data over the next 3 to 6 months. When that time comes, close attention should be paid to CPI subcomponents most sensitive to imports, such as furnishings, appliances, apparel, and electronics. Their monthly price changes may serve as leading indicators of tariff-related inflation.

Core CPI Remains Sticky: Fed Still Hesitant on Rate Cuts

The Fed’s favored measure—core CPI, which excludes energy and food—has shown no real improvement over the past three months. This is because the inflation fight has entered the “deep end.”

The May report showed housing costs rose 0.3% month-over-month, translating to an annualized pace of nearly 4%. Housing is the largest-weighted component of CPI and remains the most stubborn source of inflation. As long as housing doesn’t cool meaningfully, it will be nearly impossible to bring core inflation back to the Fed’s 2% target.

With housing contributing over 44% to core CPI, its stable yet elevated growth rate creates strong inertia. Notably, May’s 0.3% MoM increase was “adjusted down” from 0.5% the prior month. If the prior 0.5% had persisted, core CPI might have clocked in at +0.2% or higher, rather than the reported +0.1%. That would have significantly altered market expectations for the inflation path—and shaken confidence in upcoming rate cuts.

Besides housing, other structural inflation forces are also hard to reverse, especially those driven by labor costs. With a still-tight labor market, wages tend to rise and rarely fall. Companies must pass those rising costs on to consumers. This type of inflation is structural and hard to unwind in the short term.

While CPI doesn’t directly reflect employment data, a strong labor market remains the fuel behind persistent service-sector inflation.

Fed Still in Wait-and-See Mode

In sum, the Fed has little reason to rush into rate cuts over the coming months. The future of rate policy—whether to cut, and by how much—remains highly uncertain.

Ultimately, the Fed’s decision will hinge on the intersection of inflation and employment data over the next three months, along with broader geopolitical and trade developments.