A just-published report updated our view on the U.S. inflation outlook. Last year’s spike is unwinding, driven by falling goods prices. Year-over-year core inflation will continue to decline as goods inflation drops and eventually as rental inflation cools. This will be short-term bond-supportive as it will encourage the Fed to halt its policy tightening likely with a 5-5.25% policy rate in the coming months.
While U.S. core inflation will decelerate in the first half of the year, it is most unlikely to asymptote to 2% in the coming year, especially with solid wage growth heralding a persistently high rate of non-rent services inflation. This, in turn, implies that the Fed will ultimately keep the policy rate elevated for much longer than the bond market anticipates. MRB continues to expect another upleg in bond yields down the road, likely when current expectations for Fed rate cuts starting later this year are priced out of fixed-income markets.
In the end, it will take a recession and significant rebuilding of economic slack for inflation to return close to the Fed’s target of 2%.