Something For Your Espresso: The Inflation Mirage, Cooling Prices or Just a Pause?

Good morning from Copenhagen.
After a volatile week, markets can finally take a breather following the Central Bank meetings. Overall, policymakers provided little in the way of surprises, with most central banks offering minimal forward guidance. The key data release today is PCE, with the headline figure expected at 0.3% MoM and core at 0.2% MoM. However, a key point of divergence between CPI and PCE is that much of the disinflation seen in the CPI report is not reflected in key subcomponents of PCE, meaning the decline in the Federal Reserve’s preferred inflation gauge may be less pronounced. CPI showed some cooling, but much of that disinflation was concentrated in categories that do not carry the same weight in PCE, such as used cars and certain shelter components. Given this discrepancy, PCE inflation may not decline as significantly as CPI, reinforcing the notion that inflation remains persistent in key areas of the economy. This, in turn, could limit the Fed’s ability to pivot toward rate cuts as quickly as markets anticipate.
One of the more notable developments has been the pickup in goods inflation, which could have significant implications for the broader inflation trajectory. The widely accepted narrative has been that supply-driven inflation has fully unwound, but recent data suggests that may no longer be the case. Freight rates have been steadily increasing, which could indicate that goods prices may begin rising again. Historically, the relationship between freight costs and goods inflation has been strong, with freight rates leading inflation trends by several months. If this dynamic holds, goods inflation could remain a concern in the coming months.
At the same time, housing inflation remains in focus. While Powell noted that shelter inflation appears to be unwinding, which could provide justification for future rate cuts, surveyed rent data suggests otherwise. Zillow Real Estate Prices, which have a strong correlation with PCE housing inflation, have started to rise again. If this trend continues, the expected disinflation in the shelter component may be short-lived, creating another potential obstacle for a more accommodative Federal Reserve stance.
Another area of concern is the services sector, where ISM Services Prices Paid has shown signs of rebounding. This indicator typically leads inflation trends in the services sector by three months, and since services inflation has been the most persistent component of overall inflation, this development warrants close attention. If services inflation remains elevated, the Federal Reserve may find it increasingly difficult to justify rate cuts, despite some progress in other areas.
However, Powell did mention that shelter inflation appears to be unwinding, which could give the Fed an opportunity to justify a rate cut if necessary.
Chart 1.a: Freight rates indicate a potential rebound in goods inflation.
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