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Quarterly Inflation Outlook (Q2, 2017)

Executive Summary

• Measures of US inflation have recently decelerated.
• A large part of the deceleration is attributable to two quirky and surprising items. The first is that the CPIs for pharmaceuticals, and even more so for Medical Professional Services, have abruptly and inexplicably plunged.
• The second quirk is that wireless telephone services plunged 7% month-over-month and is now deflating at 13% year-over-year. This happened because the BLS methodology for sampling wireless telephony greatly exaggerated the effect of a recent introduction by some carriers of wireless data plans.
• The AHCA (the current proposed replacement for Obamacare) seems to keep most of the worst elements of the law (from an inflation standpoint), although one part of the proposal would probably have a near-term decelerating effect.
• On net, though, we think these two quirks that operate on core services CPI are temporary.
• Housing pressures are easing slightly, but housing inflation isn’t likely to decline meaningfully any time soon.
• European inflation is finally rising, in delayed response to money growth faster than 5% and a recent small rise in interest rates.
• We have changed the zig and zag in our forecasts, expecting now that 2017 inflation will rise only moderately from here before rising further in 2018. Previously we expected 2017 to have a larger rise but then 2018 to be flat from there.
• TIPS are cheapening again, but European inflation bonds are where the real value is.
• Equity valuations remain egregiously rich, and dangerous.