Our newly launched BlackRock Inflation GPS signals greater potential for U.S. and eurozone monetary policy divergence than markets expect.
We developed the BlackRock Inflation GPS, introduced last week, to help see through the noise of monthly inflation releases and give a guide on the near-term outlook for core consumer prices. As detailed in our September Global macro outlook, we expected the U.S. core Consumer Price Index (CPI) to reverse some of this year’s surprisingly sharp slowdown. The release of the August CPI stabilizing core inflation in line with the signal from the U.S. Inflation GPS.
The Inflation GPS, developed with BlackRock’s Scientific Active Equity team, incorporates big data on price trends and a daily-updated “nowcast” of inflation-related statistics to give a read on where core inflation is headed in major economies. Inflation has stepped into the spotlight this year: Upbeat and more synchronized global growth has not prevented weak inflation readings in major economies. Cooling US core inflation this year was driven by major one-off drops–especially the sharp fall in wireless costs due to changes in major pricing plans–as well as some moderation in a few key categories such as housing.
The US Inflation GPS, in the chart below, reflects the sudden nature of the drop. But our work on the GPS suggests the core CPI, excluding food and energy costs, should climb back to near 2% by early 2018. For a market still skeptical about the Federal Reserve (Fed) proceeding with policy normalization, this should serve as a wake-up call that the Fed can press ahead. This assumes no market hiccups from a likely announcement in September laying out plans to shrink its balance sheet. At the moment, we see a greater than 50% chance the Fed raises interest rates in December.
Our eurozone Inflation GPS suggests that core prices, as reflected in the Harmonized Index of Consumer Prices, are likely to stay muted and move sideways around current levels at 1.2%-1.3% heading into 2018. The Inflation GPS helped anticipate the quick inflation recovery that took root in late 2016, led by the text mining mentions on prices and the nowcast’s inputs from Purchasing Managers Index business surveys on prices. But that rise is over for now. The European Central Bank remains very far away from hitting its objective for headline inflation of slightly below 2%. Slack remains a large drag on inflation, with monetary policy only a small offset. That’s why an accommodative monetary policy stance is still needed to foster a longer economic recovery and to keep eliminating slack, we believe.
We see policy divergence between the US and eurozone returning as an investment theme. This may be a factor that sparks a reverse in the US dollar’s slide. We see the inflation outlook as negative for US Treasuries but potentially helping eurozone government bonds. We also like US inflation-linked bonds relative to the richer pricing of medium-term eurozone equivalents.
The iShares Barclays TIPS Bond Fund ETF (NYSE:TIP) was unchanged in premarket trading Wednesday. Year-to-date, TIP has gained 2.09%, versus a 12.86% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of BlackRock.