By Tiffany Wilding, North American Economist, and Allison Boxer, Economist at PIMCO
This week focus turns to inflation, where recent commodity price weakness will become apparent across the range of inflation measures. We also think core inflation will decelerate on a month-over-month basis from last month’s alarmingly hot print. However, we expect another firm core CPI print and rising unit labor costs to reaffirm the strength in underlying inflation pressures.
The US CPI report will likely present somewhat more mixed messages about inflation. We think the most important thing to watch is whether rental measures remain on the pace from last month, or if that was a one-off deviation from established trend. Our baseline is that the CPI report shows continued strength in the underlying trend of inflation, while headline inflation moderates significantly.
- Headline: The market sees a 0.2% rise in overall inflation (8.8% year-over-year), dramatically softer than the 1.3% m/m headline print last month. This reflects the recent commodity price weakness, and suggests that headline CPI peaked at 9.1% y/y in the June report.
- Core: Meanwhile we think core will 1) lose some sequential momentum, 2) still not peak on a y/y basis, 3) remain uncomfortably hot for Fed officials. We see downside risks to consensus forecasts due to some one-off factors in volatile categories. We see a risk that core CPI will round down to 0.3% m/m, but with risks towards rounding up to 0.4%, both of which are below consensus (0.5% m/m) but still not great news for the Fed. In particular, we think the reasons that our forecast is below consensus is due to more temporary factors, like softer airline prices due to cheaper jet-fuel and a temporary reprieve for used car prices. We expect the underlying trend to remain very strong, with persistence in the shelter measures that remain key for gauging the broader trend of inflation. We’re also very focused on whether or not the surge in retail inventory-to-sales ratios ultimately shows up in retail prices in this CPI report – it’s been notably absent to date.
In other inflation news, preliminary University of Michigan consumer survey data for August will be released Friday. As usual, main focus will be on any change in long run inflation expectations. Our version of the Fed’s Common Inflation Expectations index has actually ticked down slightly in recent weeks. The commodity price softening will also be clear in trade and producer price data released throughout the week. Another quarter of economic contraction sets up what is likely to be a weak productivity report for 2Q. Importantly, we think that unit labor costs will be very firm, consistent with the broader set of indicators that wage gains have been strong and highlighting the risks to margins from the current economic backdrop.