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U.S. Goods Inflation To Cool, But Watch Out For Service Sector Inflation – April 18, 2022

A just-published report updated our outlook for U.S. inflation, concluding that although there should be some “good” short-term news, the cyclical outlook remains worrisome: we expect much higher inflation than the consensus and Fed anticipate in the coming years. Consequently, we remain bearish on bonds, even though a near-run pause in the yield uptrend seems probable.

While concerns about supply chain problems and soaring goods prices have dominated the inflation debate in the past year, the more worrisome trend has been rising service sector inflation, even though spending on services is still running below desired levels. Services comprise a much larger weight in core CPI (or in the core PCE deflator) than goods, and thus have already contributed significantly to the rise in the core inflation rate over the past year. Goods inflation will slow as demand cools and supply chains gradually become less distorted. However, this will only provide temporary relief to the core inflation data: as mobility improves, especially global mobility, spending on services will strengthen. The latter, in turn, will sustain the already entrenched uptrend in services inflation, especially as wage growth also is now in a solid uptrend.

Expectations in the Treasury market (and in other government bond markets) and within the FOMC are that inflation will steadily decline to the 2% environment of the 2010s. We do not foresee such a benign outcome without much higher bond yields and outright tight monetary conditions.