A just-published report updated our outlook for U.S. inflation. As anticipated, last week’s July CPI report confirmed that inflation has peaked, and we expect a moderation in the coming months. This, in turn, will allow the Fed to slow its rate hikes this autumn and likely pause by yearend.
However, despite a meaningful deceleration in goods inflation, core inflation will get little respite from services pricing, due to the lagged impact from upward momentum in many sticky components (such as rental inflation) and the pass-through from solid and still rising wage growth. Even under a range of possible outcomes for goods and services inflation, our analysis showed that it will be extremely difficult for core inflation to continue easing toward the Fed’s target of 2% over the next 12-18 months, outside of an outright recession (which we currently do not see as likely).
Consequently, any yearend policy rate pause will ultimately prove temporary; bond yields will eventually resume rising once investors realize that underlying inflation has stabilized well above 2% and with a bias to move higher over time until meaningful economic slack develops. We remain cyclically bond-bearish.