This post originally appeared on The Basis Point: Inflation Will Drop To 2.5% By 4Q 2023: Goldman Sachs
On Friday, May’s CPI inflation rate was 8.6% annualized. This was a renewed peak following March’s 8.5% level, causing stocks, bonds, and crypto are selling off. Rates rise when bonds sell, and the 2022 mortgage rate spike continues, with 30-yr rates in the 5.75%+ range. But what if inflation drops to 2.5% by 4Q 2023? That’s what today’s inflation outlook from Goldman Sachs says.
Here’s the fine print…
Consumer Price Index (CPI) inflation is known as the “headline” number. It has food and energy (aka gas) prices included. This is an important inflation measure, but the Fed will focus more on the Personal Consumption Expenditures (PCE) index for policymaking.
And more specifically, they focus on Core PCE, which excludes food and energy. But wait, I drive and eat! Why does the Fed focus on “Core” inflation that excludes this? They do this because these items are especially volatile.
So for better or worse, Core inflation measures have more weight in policy decisions. And bond markets sell (causing rates to rise) when investors see higher inflation (because inflation erodes a bond’s future cash flows).
If we look at Goldman’s Core PCE outlook for 4Q 2022 (above), it shows inflation dropping to 4.2%.
And Core PCE inflation in Goldman’s outlook drops to 2.5% by 4Q 2023.
This is encouraging, especially on a day like today where markets are still reeling from higher-than-expected May CPI on Friday.
The last Core PCE inflation reading was 4.9% for April 2022, down from a peak of 5.3% in February.
So the next thing to watch for is whether May Core PCE inflation on June 30 continues trending down. Or whether it ticks up like CPI did after 2 months of trending down.
If Core PCE also ticks up, we can expect further bond selloff, which would push rates higher — and would push inflation projections higher.
That Core PCE release is 2 weeks away, so here are today’s inflation projections in the meantime.
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