The United States recorded its fastest pace of inflation since 2023 as the Consumer Price Index rose 4.2 percent year on year in May. The data came as tensions in the Middle East continued to affect energy costs, adding extra pressure on expectations for the Federal Reserve’s interest rate path.
Energy prices take center stage
The most pronounced increase over the past 12 months was seen in the energy sector. Rising gasoline and fuel expenses have heightened financial strain on American households. Market watchers note that this surge in inflation may further undermine the likelihood of any near-term interest rate cut.
With May inflation in the US climbing to 4.2 percent, concerns are mounting that price pressures may prove more persistent than previously thought.
Following the release of the inflation data, the US dollar slipped 0.2 percent against a basket of six major currencies, settling at 99.75. Nonetheless, the dollar index stayed close to its two-month high of 100.214, reached earlier in the week. While expectations for a rate hike in September moderated slightly in short-term rate markets, the probability of an increase by October remains significant.
Middle East tensions rattle markets
US President Donald Trump accused Iran of delaying too long in reaching an agreement, warning that Tehran would bear the consequences. In response, Iranian authorities indicated they were reassessing diplomatic contacts after a night marked by retaliatory attacks. These events elevated global market anxiety, particularly through impacts on energy prices.
Dominic Bunning, Head of G10 FX Strategy at Nomura, commented that despite volatility, markets still lean toward some kind of deal or compromise being more likely.
The Japanese yen remained flat against the US dollar at 160.34, a level widely seen by investors as the threshold for potential official intervention. Analysts say the Bank of Japan is widely expected to raise rates at its June 16 meeting, though a lone move may not be enough to lend lasting support to the yen.
The Canadian dollar ticked up 0.2 percent after the Bank of Canada left rates unchanged. Bank Governor Tiff Macklem stated they would not hesitate to raise rates if necessary. Sterling also gained 0.3 percent. Meanwhile, Bitcoin hovered just above $62,069 with only limited movement.
All eyes on the Fed’s June meeting
These developments come just ahead of the June 16–17 meeting of the Federal Reserve. The gathering will mark the first meeting led by new Fed Chair Kevin Warsh, who succeeded Jerome Powell earlier this year. The Fed has held its policy rate steady in the 3.50 to 3.75 percent range for three consecutive meetings.
Futures markets are currently pricing in less than a 10 percent chance of a rate cut through 2026. By contrast, expectations for a possible return to rate hikes have resurfaced for the first time since 2023. Warsh, who served as a Fed Board member from 2006 to 2011, is known for a tough stance on inflation and skepticism regarding monetary expansion.
However, Seth Carpenter, Chief Economist at Morgan Stanley, highlighted that a change at the helm may not result in any dramatic policy shift, since rate decisions are made by the entire board rather than a single leader. J.P. Morgan sees the Fed likely to stay on hold through 2026 if inflation remains elevated, with a possible 25-basis-point hike emerging only during the third quarter of 2027.
