SEPTEMBER 2025
Is US inflation resurfacing just as the Federal Reserve embarks upon rates cuts?
A repeat of the 2021/22 surge in price levels is unlikely, but cost pressures are starting to mount again.
As the chart below shows, the Trump tariffs are now filtering through into loftier producer prices with US PPI coming in higher-than-expected, at 3.3%y/y, in July.
History suggests that headline CPI (dark blue) and core CPI (light blue) rates will soon follow suit.
However, we are unlikely to see a return to the double-digit inflation witnessed at the start of the decade.
Although the tariffs are putting upward pressure on factory gate prices, the general supply chain bottlenecks that dominated the pandemic-era inflation have largely disappeared.
The demand side also argues against a pronounced inflationary shock with the global business cycle struggling to accelerate despite bundles of fiscal support. This is in stark contrast to the consumer boomlet that greeted the end of lockdowns.
In short, near-term US inflation risks are skewed to the upside, but there is little on the horizon to suggest we are on the verge of a major inflationary wave that would spark a series of rate hikes.
The chart below shows the strong link between US core CPI inflation (blue line) and the US Manufacturing ISM (red line).
The latter is a monthly survey-based indicator that measures the health of US industry. Readings above 50 signal expansion and those below 50 are consistent with a contraction.
The two readings have a high correlation with one another, but on a lagged basis. Specifically, US core CPI tends to follow what the ISM does, but on a 20-month lag.
This means we can use historic ISM readings to project how core CPI is likely to trend.
As things stand, the relatively sluggish state of the US manufacturing sector over the past couple of years (in which the ISM index has been stuck in the 47-51 range) means the near-term outlook for US core CPI inflation is relatively subdued.
It ticked up to 3.1%y/y in July, but absent any sudden resurgence in the manufacturing ISM survey, core CPI is likely to remain well below the near 7%y/y peak it reached in late 2022.
In late 2020, a sudden surge in global shipping costs proved to be a harbinger of the major inflation shock that was to come.
Higher producer prices (PPI) and consumer prices (CPI) soon followed suit, culminating in the worst inflationary episode since the 1970s and a series of coordinated Central Bank rate hikes that shook financial markets.
The chart below suggests the environment is less threatening this time around, with the cost of shipping a 40ft container from China to Europe continuing to fall towards a multi-year low.
Looking at the supply side more generally, the US trade war clearly poses a near-term threat to the becalmed inflation backdrop, but there are mixed views over how inflationary the Trump tariffs will be.
US input prices are starting to inch higher, but companies are unlikely to pass all of the cost increases onto the end-consumer. This suggests the bigger impact may be on corporate margins.
The US Congressional Budget Office (CBO) recently warned the tariffs would raise US average inflation by 0.4% in both 2025 and 2026.
If this transpires to be the case, such a benign outcome would be unlikely to derail the prevailing bull market in risk assets, but a return of inflation concerns could well amplify market volatility going forward.
As we’ve noted before, monetary policymakers tend to be fixated on inflation expectations, much more than actual CPI or PPI prints.
This is because they inform what market and economic participants are thinking about the outlook for future prices, which can quickly become self-fulfilling.
For example, when higher inflation is anticipated workers will strive for higher wage growth and businesses will look to increase prices on their goods and services. A general rise in costs across the economy can thus soon unfold, but the converse is true when prices are expected to decline.
The chart below shows market-derived figures for US 2yr, 5yr and 10yr US expectations.
The spike in all three measures between late 2020 and early 2022 helps to explain why the Federal Reserve was panicked into the major rate-hike cycle that ultimately led to a painful drawdown in risk assets.
Fast forward to today and the picture is more nuanced.
The recent upturn in 2yr inflation expectations (dark blue) is consistent with the nascent fears that the Trump tariffs could fuel another round of inflation.
However, unlike the 2021/22 inflation scare, longer-dated inflation expectations are not trending higher. Note how the 5yr expectations (red line) and 10yr expectations (light blue line) are moving sideways.
This is consistent with the idea that tariffs are typically inflationary in the short-term but can be long-term deflationary, as aggregate demand wanes in the face of higher costs.
It is also significant that Central Bankers tend to put most store in the longer-dated expectations.
Simply put, the Federal Reserve should remain relatively relaxed about the inflation backdrop unless, or until, those red and light blue lines start to trend higher.
The content of this communication is for information purposes only. Bentley Reid believes that, at the time of publication the views expressed and opinions given are correct but cannot guarantee this and readers intending to take action based upon the content of this communication should first consult with the professional who advises them on their financial affairs. Any companies cited in this report are used to support the view of the authors, and should not be construed as recommendations to purchase or sell the underlying securities. Neither the publisher nor any of its subsidiaries or connected parties accepts responsibility of any direct or indirect or consequential loss suffered by a reader or any related person as a result of any action taken, or not taken in reliance upon the content of this communication.
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