Wall Street traders are shifting focus to Wednesday’s May CPI release following last Friday’s sharp market rout. Investors widely warn the inflation print could hit a multi-year high, adding substantial pressure on the Federal Reserve to raise interest rates.

Strong Payrolls Fan Rate Hike Expectations

The latest U.S. nonfarm payrolls report handily beat market estimates. The economy added 172,000 jobs in May, nearly double the consensus forecast of 85,000, while the unemployment rate held steady at 4.3%.

Shortly after the data release, the 10-year U.S. Treasury yield jumped to 4.55%, hitting a two-week peak. The policy-sensitive 2-year yield climbed to 4.18%, its highest level since February 2025. The Nasdaq Composite tumbled 1,121 points, or 4.2%, marking the largest single-day point drop in the index’s history.

Interest rate swaps now fully price in one Fed rate hike before the end of 2026. The probability of an October rate increase stood at around 60%, while a December hike is viewed as all but certain.

CPI Projected to Hit Four-Year Peak

Headline CPI is forecast to rise 4.2% to 4.3% year-over-year in May, the strongest reading since 2023 and a notable jump from April’s 3.8%. Core CPI is expected to edge up from 2.8% to 2.9%. Soaring energy costs continue to lift headline inflation, while higher jet fuel prices and a tight labor market put upward pressure on core services.

CPI-linked swaps point to a 4.3% year-over-year increase. Royal Bank of Canada projects a 0.5% month-on-month rise for headline CPI. Following the robust jobs report, economists at BNP Paribas revised their outlook and now expect three consecutive Fed rate hikes starting in December.

Three Key Drivers Stoking Inflation

David Mericle, Chief U.S. Economist at Goldman Sachs, outlined three major inflationary forces in a recent research note:

“tariff pass-through effects, elevated oil prices driven by the Iran conflict, and AI-related investment demand that is mismeasured and overstated by some market participants.”

These combined factors are set to keep core PCE inflation above 3% for the full year of 2026.

Goldman Sachs has scrapped all rate cut forecasts for 2026. It pushed back the timeline for its final two projected cuts to June and December 2027, and raised the odds of a 2026 rate hike from 10% to 20%.

“The narrative that the Fed would have to cut rates is gone — killed by the data,” said Luigi Buttiglione, CEO of LB Macro. He anticipates a total of 50 basis points of rate hikes this year, most likely kicking off in September.

Fed Chair Warsh Faces Policy Dilemma

Persistent geopolitical tensions have kept oil prices elevated. The U.S. economy’s resilience has created headwinds for the bond market and complicated the policy outlook for newly appointed Fed Chair Kevin Warsh, who may face pressure from the White House to lower borrowing costs.

“If Kevin Warsh had hoped to cut rates immediately after taking office, that now looks impossible,” 

said Christophe Boucher, CIO at ABN AMRO Investment Solutions. “The labor market is far too strong to justify easing.”

CMB International noted that while markets may have overreacted to rate hike fears, energy shocks and supply chain disruptions will keep inflation elevated. The Fed is therefore likely to maintain a hawkish rhetoric in the near term.

Any fresh signs of accelerating inflation in Wednesday’s CPI or Thursday’s PPI reports will reinforce expectations that the Fed will remove its easing bias from official policy statements.