Is disinflation back on track?

The latest news on inflation has been pretty good. It has also been extremely weird. And that weirdness is, in a way, the message.

With underlying inflation fairly low but probably still above the Fed’s 2% target, and people still worried that it might go back up, quirky measurement issues can lead to big mood swings that are quickly reversed when the next numbers come in — or sometimes even a few hours after the initial announcement, once knowledgeable people have had some time to dig into the details.

There were two big official inflation reports in the past couple of days: the producer price index (what we used to call wholesale prices) on Tuesday and the consumer price index on Wednesday morning. There was also a private survey from the National Federation of Independent Business that may add some clarity.

So what do I mean by “weirdness”? On Tuesday, I was busy most of the day with plumbers and dentists, so I was able to check in on events and commentary only once in a while. But this enforced limitation on the information flow might actually have given me more perspective. The first thing I saw was a hot PPI, with inflation coming in well above expectations. There was much wailing and rending of garments. Then, as the analysts I follow had time to parse the details, they started to declare that this was actually a good report.

Financial markets seemed to agree. One quick and dirty way to judge how markets view inflation data is to look at the yield on two-year U.S. Treasurys, which largely reflects what people think the Fed is going to do. If inflation looks hot, they expect the Fed to keep rates high and maybe even increase them; if it looks cool, they expect the opposite.

And if you look at two-year yields over the past few days, you see the market reaction matching my sense of the commentary. Yields spiked when the PPI report was released, then fell back once there was time to dig into the numbers, ending the day lower than they started.

On the other hand, markets from the get-go liked the CPI, which seemed to show inflation resuming its downward trend, with yields falling sharply. But analysts were still digging into the details. Will they be less optimistic by Wednesday evening? Probably not: Early commentary seems, if anything, to be saying that the numbers were even better than they first appeared. But after Tuesday, I’m going to wait and see.

I also mentioned the survey from the NFIB, which represents small and medium businesses. One question it asks is whether businesses are planning to raise or lower prices over the next three months; the percentage difference from current numbers is often a useful indicator of inflation trends. And that spread is currently close to what it was before the pandemic, although slightly higher.

So my best guess? The acceleration in measured inflation over the past few months was probably a statistical illusion; inflation wasn’t as low as it seemed in late 2023 but probably hasn’t risen much, if at all. Underlying annual inflation is probably around 2.5%, maybe even less. So my guess is that we’ve already won this war — that we have basically achieved a soft landing, with low unemployment and acceptably low inflation.

But I could be wrong, and even if I’m right, it’s going to take at least a few more months of good inflation news before this happy reality sinks in.

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