BofA: Transitory inflation to crash

BofA with the note to break inflationists hearts. What is so amusing about this is that as transitory inflation reverses, it is going to deliver a very large disinflationary shock next year at which point we’ll have to argue that that is transitory as well!

Strong price pressures have materialized in the economy over the past year, with a notable acceleration in the last few months. With core CPI inflation at 3.8% yoy in May, we must assess how much of the acceleration in inflation is due to transitory factors, and how much will be sustained over the medium term. Here we contribute to the discussion by introducing the BofA US transitory inflation meter. Our meter is currently at an all-time high, suggesting that there is significant scope for a pullback over the next year (Exhibit 1,Exhibit 2). Our meter compares core inflation to measures of underlying inflation such as trimmed mean and median inflation, which take a systematic approach to omitting outliers. The degree to which core inflation has differed from underlying inflation indicates the extent of transitory inflation pressures. We also focus on expectations: we subtract long-run expectations from their short-run counterparts, in order to extract the transitory component of expectations. Overall, our meter boils down to a scaled version of the average of 11 estimates of transitory inflation. Importantly, our meter does not itself give a sense of persistent inflation, only the bias in broader core inflation. However, we can subtract the underlying average of the 11 transitory estimates from core PCE and core CPI to calculate an implied persistent trend. The implied persistent trends have been rising alongside transitory inflation up to 2.3%for core PCE and 2.5% for core CPI. This suggests that as transitory inflation pressures ease, core inflation is likely to settle above the Fed’s 2% target. As we have been writing, we believe the risks are growing for higher persistent inflation amid wide-scale evidence of inflation pressures, including our own news-based indicator, which could ultimately become embedded in the inflation psychology. We recommend paying close attention to: 1) stickier measures of inflation such as owners’ equivalentrent (OER), 2) wages, and 3) long run inflation expectations. For now, we remaincomfortable with the view that after a hot 2021, core PCE inflation will settle down to2.1% in yearend 2022 and core CPI at 2.5%; consistent with above-target inflation.

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