Macro charts, could inflation surprise again?

In recent weeks, the market's attention was focused on stabilizing prices and the end of interest rate hikes. Wall Street, after a deeper correction in early October, has now shifted to almost euphoric increases, with indexes just a few percent off their historical highs. This positive sentiment is supported by a stabilizing U.S. job market and declining inflation. Adding to this a rebounding industrial sector, markets currently perceive it as the perfect recipe to avoid recession while bringing inflation to target. However, are the data really that optimistic, and is the risk of inflation rebounding decreasing? Let’s examine some charts on U.S. inflation for more details.

Although the job market has begun to stabilize, wages remain high, though not as high as at the turn of 2021-2022. Inflation is falling, and so far, the progress is noticeable.

The inflation issue in Western economies largely arose from the central banks' decisions during the COVID pandemic. However, as quickly as inflation appeared, it now seems to be rapidly subsiding. The only apparent obstacle to further slowing price growth seems to be a strong supply shock, such as an increase in oil prices due to escalated conflict in the Middle East. Currently, the chances of such a pivot are small, and markets are not concerned about this scenario.

High inflation readings are primarily driven by high housing rental prices. Many factors support the normalization of inflation in recent months, such as the slowdown in the growth of energy components, food prices, and, most importantly, the upcoming decline in shelter.

The Shiller Home Price Index indicates an impending decline in the growth of rental prices – currently the main component of inflation.

Assuming constant month-to-month changes, inflation should gradually head towards 2.0-2.5% by the end of 2024/2025. It’s important to note that we may see a slight inflation rise due to the base effect at the beginning of 2024. However, if month-to-month changes maintain the average of the last 10 years, around 0.23% (or less, excluding the inflation increase period from 2021), we should remain on a downward trend (light green path).

The data suggest that the U.S. economy is currently heading in the right direction. Although the Fed maintains hawkish bias, inflation should gradually ease. However, it’s important to remember that we are still in an environment of high interest rates, and their impact on the economy may be evident in 2024. Until now, the U.S. economy has remained relatively resilient thanks to the financial cushion maintained after the 2020-2021 money printing and the low cost of debt during that period.