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    Instant Insights: A bumpy road to 2%

    Instant Insights: A bumpy road to 2%

    January 11, 2024 Fixed income
    • Headline CPI slightly higher than expected, while annual Core CPI grinds lower
    • We expect major progress toward 2% inflation by the summer and do not expect to see a rate cut until then
    • Our base case is for tensions in the Red Sea to have a muted impact on inflation

    Headline CPI accelerated slightly more than the market expected, by 0.3% in December, taking the year-on-year rate from 3.1% to 3.4%.

    Core CPI continued to make steady progress. It remained at 0.3% month-on-month, and on a year-over-year basis, dipped below 4% to 3.9%.

    We expect CPI to continue to make steady, if bumpy, progress towards the Fed’s 2% target over the course of the year.

    The “last mile” proves bumpy as CPI trends sideways

    Energy prices rebounded slightly on a month-on-month basis, particularly in areas such as electricity and energy services, despite an unseasonably warm winter. However, the other non-core category, food prices, continued to moderate on a year-on-year basis.

    Figure 1: Prices generally rose slightly across the major CPI categories


    Source: Bureau of Labor Statistics, FRED, Bloomberg, January 2024

    The “stickier” components of inflation remained relatively stubborn. Nonetheless, shelter (the largest component of the index) continued to make steady progress (Figure 2), in line with our projections. Meanwhile, non-shelter services inflation (known as “supercore”), remained fairly elevated.

    Figure 2: Shelter inflation is improving but “supercore” (non-shelter services) remains stubborn


    Source: Bureau of Labor Statistics, FRED, Bloomberg, Insight, January 2024


    Our current base case is for geopolitical tensions to have a muted impact on US inflation

    Pandemic-era supply chain bottlenecks have long dissipated (Figure 3).

    However, geopolitical tensions may potentially reignite inflationary pressures in goods. Attacks on container ships in the Red Sea are diverting transit from the Suez Canal (where 11% of global maritime trade traverses1) to the Cape of Good Hope (at the Southern tip of Africa – which has seen a 76% year-on-year increase in traffic over the last week). This adds ~10 days or 3,300 miles to a one-way trip. Container freight prices have doubled since November2, but remain far lower than during the pandemic.

    Figure 3: Supply-chain pressures have dissipated, but we are watching shipping activity closely


    Source: Federal Reserve Bank of Kansas, Federal Reserve Bank of Dallas, Federal Reserve Bank of Philadelphia, Macrobond, Insight, January 2024

    For now, our base case is that the impact on US inflation will be muted, but we are watching developments closely.

    It will be bumpy ride to 2% inflation

    We expect to see headline CPI close to or at 2% by the middle of the year, but this print is another reminder that it will be a bumpy ride.

    We think the ongoing progress on inflation sets the stage for Fed rate cuts from the summer. However, we believe markets are significantly overestimating the probability of any cuts before then. As a result, we believe investors will find many opportunities to lock in compelling yields from fixed income assets ahead of the cutting cycle.

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