On this basis, we revert to the positioning of US monetary policy. We retain the view that the Federal Reserve needs to tighten the ‘screw’ more, and it needs to see a meaningful reversal in services inflation and wages growth.

To hear Paul's thoughts, watch the interview below. A summary follows.

In the graph above, we see that goods inflation has indeed been transitory. On a 6-month SAAR basis, goods inflation stood at -0.6%, with the headline CPI figure of 3.3% being led by services inflation of 6.3%. 

Rent is 34% of the US CPI.  It has been the significant driver of US services inflation and Headline CPI. With rent being such a large component of CPI, it is little surprise that wages growth is so led by rental inflation. 

We consider the official data and the Zillow rent index. 

Zillow is showing new lease rents (as opposed to rent increases for existing tenants) declining since September 2022. Taken together, the increase in rents has been substantial and wages are yet to recover the increases. Wages growth must significantly moderate. 

The ‘turn in the worm’ in rent and wages is simply not enough for the Fed Reserve to be able to say with any confidence that it is returning to acceptable inflation levels. The Federal Reserve is on balance likely to continue raising rates by a further 0.25%. In so doing, the US economy’s likelihood of stepping into recession increases. 

The thing markets perhaps underestimate, is that a shallow recession accompanied by higher unemployment gets the Fed to where they want to be (having been behind the curve in 2022). They want to get ahead of the curve. Inflation objectives need to be met sooner rather than later, and the Fed’s balance sheet needs to meaningfully reduce in size through quantitative tightening – short-term, enforced pain for the benefit of longer-term financial stability.