Here’s the most important thing to understand about this morning's inflation report: the scary number is the one the Federal Reserve is specifically built to ignore.

Headline CPI rose 4.2% year over year in May, the hottest reading in three years, driven by the energy-supply shock from the Iran war. That will dominate the headlines and send the nervous crowd scrambling into energy and defensive "inflation hedges."

Central banks fight demand-driven inflation. They do not, and cannot, fight supply shocks. A war-driven spike in crude oil is the single clearest example of a supply shock there is, and the Fed's entire playbook for one is to look straight through it — because raising rates does nothing to unclog the Strait of Hormuz, and tightening into a supply-driven price spike only deepens the economic damage.

The Fed knows this. The market, fixated on the 4.2% print, is in the process of forgetting it.

Digging Deeper into May’s CPI Print

And when you actually look at what the Fed cares about, the picture inverts completely. Core CPI rose just 0.2% on the month, below the 0.3% consensus. Strip out food, shelter, and energy — the cleanest read on underlying, demand-driven pricing — and inflation is running at roughly 2.4% year over year.

That is essentially at target. The honest interpretation of today's report is not "inflation is back"; it's "the economy's underlying inflation is cooling while a geopolitical oil spike temporarily distorts the headline."

That distinction is the whole ballgame, because a cooling core keeps the path to rate cuts wide open — and rate cuts are the lifeblood of the aggressive, rate-sensitive corners of the market that the defensive crowd has been busy abandoning.

This is the repositioning that matters. While the obvious trade chases oil, the more sophisticated money reads the core, concludes the Fed's easing path comes back into play, and rotates back toward risk. The footprints are already visible: even through the inflation scare this year, a handful of AI names have driven roughly half of the S&P 500's return this year.

Technology has quietly been among the best-performing sectors, and the largest allocators remain most convicted on AI while the rally broadens beyond the megacaps. A Fed that's free to cut pours fuel on exactly that fire. Here are two Zacks Rank #1 (Strong Buy) names built for it — both AI-levered, both mid-cycle, both precisely the kind of stock that outperforms when discount rates fall and risk appetite returns.

Stocks to Watch

The first is Microchip Technology (MCHP Quick QuoteMCHP - Free Report) , and it's the quintessential expression of the trade. Microchip is a microcontroller and analog chipmaker emerging from a brutal inventory-correction cycle.

The turn is now showing up in the numbers. Management guided June-quarter revenue to a midpoint of $1.45 billion, up 35% from a year ago and 11% sequentially, citing inventory correcting rapidly toward its long-term model.

The estimate revisions — the engine of the Zacks Rank — are exploding higher. The current-quarter consensus calls for EPS growth of 144.4% year over year, the Zacks Consensus Estimate has jumped 17.86% over just the last 60 days on five upward revisions and zero cuts, and MCHP carries a Zacks Rank #1 (Strong Buy). A cyclical chipmaker inflecting upward, with rising AI-edge and aerospace exposure, is a high-beta way to play both the semiconductor recovery and a potentially friendlier Fed.

Image Source: Zacks Investment Research

The second is Flex (FLEX Quick QuoteFLEX - Free Report) , the contract-manufacturing giant that has reinvented itself as a core arms dealer of the AI data center buildout.

Its latest quarter was excellent. Fiscal fourth-quarter adjusted EPS of $0.93 beat the Zacks Consensus Estimate by 8.1% and rose from $0.73 a year earlier, on revenue of $7.5 billion (up 17%), with the Cloud and Power Infrastructure segment the standout.

Flex now carries a Zacks Rank #1 (Strong Buy). It has beaten estimates in each of the last four quarters, with an average surprise of 9.5%. At COMPUTEX 2026, Flex unveiled a 110 kW power shelf for NVIDIA's Vera Rubin NVL72 platform, underscoring its "grid-to-chip" position in AI power. That spin-off is a potential value-unlock catalyst on top of the underlying momentum.

Image Source: StockCharts

Bottom Line

The defensive, buy-energy reaction takes today's headline at face value — and the headline is the head-fake.

The signal is underneath it: a cooling core that hands the Fed room to ease, and a market quietly repositioning toward the aggressive growth and cyclical-recovery names that thrive when it does. Microchip and Flex are two Zacks Rank #1 ways to be early to that move while the crowd is still staring at the wrong number.