Inflation Watch
· Inflation pressure continues to decline with commodity prices trending downwards and labor market pressures easing slightly (Charts 1 & 2). This steady unwind provides the basis for the “disinflation process” the Fed appears to be hanging its hat on.
· While index level price measures have been unwinding smoothly, the underlying inventory situation has swung from one extreme to another. Eighteen months ago, the inventory situation was one of extreme undersupply. At present, the share of manufacturing customer inventories reported as too high continues to trend upwards and is about to surpass the share reporting inventories are too low (Chart 3).
· The situation is likely to lead to downward pressure on prices, but perhaps not as much as would have been the case in recent years. In 2015, 2020, and 2023, the bottom of the inventory cycle in the U.S. manufacturing sector has been met with a steadily higher bottom in Chinese factory price data (Chart 4). The relief felt during this inventory cycle will be shallow and short-lived.
· But we are likely to see inflation measures in the U.S. decline rapidly over the course of the summer before firming in the fourth quarter off 2023 or early 2024 (Chart 5). This will provide the backdrop for an upcoming dovish pause by the Fed, and perhaps even a mistaken easing if labor market conditions deteriorate.
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