Supercore services inflation surged, after taking off last fall. And AI data center demand drives electricity inflation.

By Wolf Richter for WOLF STREET.

The all-items CPI jumped by 0.47% seasonally adjusted in May from April (+5.6% annualized), on top of the two majestic spikes in the prior two months (blue line in the chart).

CPI inflation got hit for the third month by the gasoline price spike. Electricity prices continued their spike, driven by structural demand from AI data centers. And inflation in supercore services (which exclude energy services and housing) has taken off – the worst month-to-month surge in over two years, and has been accelerating since last fall. But food prices, after the spike in April, added only a little. And goods prices without food and energy dipped.

Year-over-year, the all-items CPI jumped by 4.25%, the worst inflation reading since April 2023, according to data from the Bureau of Labor Statistics today (red in the chart).

Negative “real” Treasury yields up to 5 years.

The year-over-year increase of CPI had blown past the Federal Reserve’s policy interest rates (3.5% to 3.75%) a month earlier. With these policy rates, the Fed targets the Effective Federal Funds Rate (EFFR, blue line in the chart below), which is an overnight rate between banks.

And now, CPI, inflation at 4.25%, blew by the 2-year Treasury yield (4.16%) and the 3-year Treasury yield (4.21%). All those yields have turned negative in real terms (after inflation).

To find Treasury yields that are not negative in real terms, you can go out on the curve to the five-year Treasury yield (4.28%) and beyond.

CPI inflation for May (short bold black line in the chart) is closing in on the 10-year Treasury yield (4.55%). This puts even long-term Treasury yields at risk of turning negative in real terms.

The 10-year Treasury yield (red line in the chart) has come up over the past three months, but not nearly enough, and the spread between it and CPI inflation has narrowed to just 30 basis points, indicating that the bond market still believes that at least part of this bout of inflation will be “transitory,” so to Powell-speak.

Interest rates that are negative or very low in real terms are stimulative to the economy and inflation, providing further fodder for inflation to thrive.

Inflation in services.

The core services CPI, which excludes energy services such as electricity, rose by 0.30% (+3.6% annualized) in May from April, after the spike in the prior month (blue in the chart below).

Year-over-year, it rose by 3.4%, worst since September (red line).

What held down core services CPI were the housing CPIs, rent and Owners Equivalent of Rent (OER).

But the “supercore” services CPI – core services without rent and OER – has been accelerating since last fall and in May jumped by the most since March 2024 (more in a moment).

Supercore services inflation has taken off. Back when housing inflation was very high, Powell had referenced supercore services inflation as an important indicator of where core inflation was headed. At the time, supercore services inflation was cooling rapidly, and he used that cooling as one of the factors in rationalizing the rate cuts, while the housing inflation measures remained hot. Now it’s the opposite.

The “supercore” services CPI spiked by 0.55% in May from April (+6.8%) annualized, the worst increase since March 2024. And it has been accelerating since last fall.

The six-month supercore services CPI, which shows this recent trend, spiked by 4.3% annualized (red line).

The CPI for Owners’ equivalent of rent (OER) rose by 0.30% (+3.6% annualized) in May after the spike in April that had corrected for part of the distortions in September, October, and November last year.

Year-over-year, it accelerated to 3.3%. This is the range that prevailed before the pandemic (red line).

The CPI for OER weighs 25.9% in the all-items CPI. Combined, rent and OER weigh 33.6% of the all-items CPI.

But OER is deeply flawed as a measure of inflation that homeowners face. It tracks what a large panel of homeowners think their home would rent for; it’s a stand-in for costs that homeowners actually face, such as homeowner’s insurance, property taxes, HOA fees, repairs and maintenance, which are not included in CPI, but these costs have been surging. OER is a fundamentally flawed metric in the CPI and should be replaced by the actual costs homeowners face.

The CPI for rent of primary residence rose by 0.36% in May from April (+4.4% annualized), after the spike in April that had corrected for part of the distortions in September, October, and November. The sharp increase in May appears to correct for the rest of the distortions last fall.

Year-over-year, the CPI for rent rose by 2.9%, the biggest increase since December.

The CPI for rent of primary residence weighs 7.7% in the all-items CPI. It is mostly based on renewal rents paid by tenants; only a small portion is based on rents from newly signed leases (differs from “asking rents,” which reflect advertised rents of vacant units).

The “core goods” CPI (all goods except food & energy) dipped by 0.1% in May from April. This reduced the year-over-year increase to 1.1%.

The CPI for new and used vehicle prices, the biggest sub-category of goods, dipped a little month-to-month and year-over-year.

The “core” CPI, which excludes food and energy prices, rose by 0.21% (+2.5% annualized), in May, after the jump in the prior month.

Year-over-year, it accelerated to +2.9%, the third month in a row of acceleration and the worst increase since September (red line).

The core CPI is dominated by the core services CPI, but also includes all goods except food and energy goods.

Energy inflation: gasoline and electricity.

The CPI for energy spiked by 3.9% in May from April and by 23.0% year-over-year. Most components surged (motor fuels, electricity, other fuels), but natural gas to the home dipped.

The CPI for gasoline spiked by another 7.0% in May, seasonally adjusted, and by 40.5% year-over-year.

The price level in May approached the peak of the prior spike of inflation in mid-2022. The CPI for gasoline of all types weighs 3.6% of the all-items CPI.

The chart shows the price level of the gasoline CPI, and not the percentage change, seasonally adjusted (red) and not seasonally adjusted (blue).

The CPI for electricity spiked by 0.63% in May from March, on top of the spike in April. Year-over-year, it jumped by 5.9%.

Data center demand has been pressuring electricity prices for years. Since the beginning of 2021, the CPI for electricity has surged by 43%.

The CPI for electricity weighs 2.5% in the all-items CPI.

Demand from data centers has been increasing faster than power plants could be built, and supplying sufficient power to data centers is one of the bottlenecks the AI industry has to deal with. Electricity prices for households are regulated and generally don’t fall back, and price increases are essentially permanent, to be followed by more price increases — unlike gasoline prices that spike and plunge.

The surge of demand for electricity started in 2021, after remaining roughly flat for 15 years. No one was ready for this (my annual analysis):

The CPI for food at home ticked up by 0.1% in May from April, after the spike in the prior month.

Year-over-year, food inflation rose by 2.7%, which was slightly less than in the prior month, which had been the worst increase since August 2023 (red line).

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the mug to find out how: