Joe Seydl

Senior Markets Economist

What have we learned about inflation in the past few years – and how can these learnings guide investor outlook?

The pandemic-driven inflation shock is ending, as inflation rates in 2024 look likely to take a glidepath toward central bank targets. It’s a good time to reassess the lessons we learned, with the goal of becoming better inflation modelers.

It’s not merely an academic matter: Soaring inflation can damage both stock and bond performance, as investors were reminded in 2022.

We believe inflation is moving steadily lower. Our base case macro outlook sees moderating economic growth and cooling inflation, which is likely to continue to be supportive for both stock and bond returns. It’s now clear that the forces that drove inflation during the COVID pandemic – fiscal stimulus, supply chain disruptions, consumer spending skewing toward goods, and low labor force participation – have mostly proved temporary.1

But we acknowledge that resurgent inflation poses a key risk to our outlook. If inflation takes off again, investors could revise their expectations for central bank policy and, once again, increase the risk that it could take a recession to eradicate inflation. In such an environment, both stocks and bonds could struggle.

We don’t believe you need to fear excessively that inflation will re-accelerate in the next couple of years. But we do believe it’s important to have a framework for anticipating inflation’s path. To that end, in recent years we’ve made enhancements to our traditional models.

Here, we present five key takeaways from our latest analysis:

1. Unemployment is a less useful indicator

Wages, of course, are central to the inflation puzzle, closely watched by economists to detect any sign of the dreaded “wage-price spiral.” In traditional economic models, a lower unemployment rate – linked to higher wages – implies greater inflationary pressures. But in recent years, the unemployment rate told us little about inflation’s trajectory.

What data can we track to better understand if inflationary pressures are building in the labor market? The so-called “pressure gauge,” defined as the quits rate divided by the layoff rate, is one of our favored metrics. It explained three-fourths of the variance of wage growth in our analysis, while the unemployment rate explained only half of the variance.

The chart describes the annual % change for wage growth and z-score for pressure gauge.

The current signal from the pressure gauge finds a labor market only modestly tighter than in 2019. That’s consistent with underlying inflation rates of 2%–2.5% (i.e., modestly higher than the inflation of 2018–2019).

2. Shelter inflation moves with important time lags

Shelter inflation (from the housing market) has long been a key component of U.S. inflation, accounting for 34.4% of the Consumer Price Index (CPI) and 15.5% of Personal Consumption Expenditures (PCE) inflation.2 But during the pandemic, we learned that shelter inflation, which measures the average cost of housing, is slow moving and lags new housing rental contracts that are tracked on a monthly basis. Bureau of Labor Statistics research suggests shelter inflation lags new tenant rents by about four quarters.3

Understanding the time lag allows us to anticipate a shelter inflation trend over the next four quarters using new tenant rent data. In 2024, shelter inflation is expected to slow to a rate comparable to where it was in late 2019.4 In 2025, shelter inflation presents more of a risk. But now that we better comprehend how rental inflation pressures can build well before they appear in the official data, we are better prepared to manage that risk.

The chart describes the annualized percent change of shelter inflation.

3. Old supply-and-demand models failed spectacularly

Pre-COVID, economists typically used variables such as the U.S. dollar exchange rate and food and energy prices to model the impact of supply shocks on inflation. But these variables failed completely to capture the magnitude and breadth of the COVID-era supply-side disruptions. These included semiconductor shortages, shipping backlogs at ports and lumber shortages caused by plant lockdowns.5

The New York Federal Reserve’s Global Supply Chain Pressure Index (GSCPI), created during the pandemic and now updated monthly, did a much better job in capturing the supply chain disruptions. More recently, the GSCPI has normalized, consistent with continued inflation normalization in 2024. If the GSCPI does especially well identifying supply-side inflation drivers, another approach (pioneered by Adam Shapiro at the San Francisco Fed) excels at identifying demand-based drivers. This metric shows a cooling over the last year, though it is not yet back to the pre-pandemic rate.

4. Short-term inflation expectations matter, too

Pre-COVID, economists modeling inflation focused on long-term inflation expectations and downplayed the significance of short-term expectations. No longer.

Economists had assumed that movements in short-term inflation expectations often reflect commodity price swings, and that central bankers would mostly ignore these measures when setting monetary policy. Long-term inflation expectations, on the other hand, signaled whether consumer, business and investor expectations were anchored at central banks’ 2% target.

But in 2022, central banks faced a tough test. Long-term inflation expectations suggested that inflation would not spiral out of control. Yet short-term inflation expectations soared to multiples of the 2% central bank target.6

In response, central banks recalibrated. Fed Chair Jerome Powell argued in 2022 that seemingly anchored long-term inflation expectations could start to shift higher if realized inflation stayed too high for too long.7 At the time, high realized inflation was driving uncomfortably high measures of short-term inflation expectations.8

Lesson learned: Economists must now pay closer attention to short-term inflation expectation measures.9

The chart describes the one-year ahead and 10-year ahead expected inflation in percent.

5. Energy shocks sting, especially outside the United States

That energy shocks matter much more in economies beyond the United States and Canada is a longstanding, well understood trend. But the COVID experience revealed how powerfully those shocks can pass through to non-energy inflation.

Germany’s case is dramatic. The estimated passthrough excluding the pandemic is statistically indistinguishable from zero, but the measure jumps markedly when pandemic-era data is included. After Russia invaded Ukraine, Germany halted the Nord Stream pipeline project that brought Russian natural gas to Germany. The disruption caused unprecedented energy price spikes.10

The episode reminds us that historical data can fail to predict a country’s vulnerability to a novel shock.

Inflation outlook: The worst is behind us

Finally, post-COVID we better understand how inflation captures people’s attention in a nonlinear fashion. Here’s what we mean by nonlinear: When inflation falls below some threshold, the general public and market participants do not perceive it to be a problem. But once inflation rises above that threshold, it quickly becomes alarming – and often a dominant factor in market performance.

For U.S. inflation, that threshold appears to be 3%. If inflation remains at or below 3%, we expect inflation to fade as a dominant driver of market returns.

Some market participants worry that inflation could re-accelerate in 2025, following Fed rate cuts in 2024 and a possible pickup in shelter inflation. We acknowledge the risk, but it’s not our base case. On the geopolitical front, the fluid and tense situation in the Middle East presents a distinct risk to the inflation outlook, particularly from the perspective of defense spending. Yet absent another major military shock impacting the global economy, we expect inflation will remain below 3% through 2025.

Inflation is a critical economic variable, and anticipating its path is, necessarily, a challenge. Our approach to inflation modeling is not radically new. But we know more about inflation than we did in 2018 and 2019, and we think our analysis is now more refined. We hope this revised framework helps our clients in building investment portfolios for a variety of inflationary regimes.



Source: BLS, Haver Analytics. Data as of 2020. We prefer the word “temporary” over “transitory” in describing the recent inflation shock because in 2021–22, the latter carried a specific meaning: that central banks wouldn’t hike aggressively to bring pandemic-driven inflation back down to target. In this context, the transitory narrative was wrong.


Sources: BLS, BEA, Haver Analytics. Data as of December 31, 2023. The main reason shelter carries a higher weight in CPI than in PCE: PCE weights are determined by actual consumer spending, whereas CPI weights are determined by surveys that ask consumers to self-report what they regularly spend on a variety of items.


Brian Adams, Lara Lowenstein, Hugh Montag et al., “Disentangling Rent Index Differences: Data, Methods and Scope,” BLS Working Paper 555, U.S. Bureau of Labor Statistics, October 6, 2022.


One caveat: New tenant rent indexes are highly susceptible to end-of-sample revisions, since housing units in the full sample are surveyed only every six months. As a result, shelter inflation projections based on new tenant rents need to be continually monitored and updated when revisions occur.


That the GSCPI can capture these specific sector shocks effectively at the macro level is promising, as it would not make sense for macroeconomists to include a variety of sector-specific variables in inflation models.


Source: Bloomberg Finance L.P. Data as of 2022.


Jerome H. Powell, “Monetary Policy and Price Stability,” Speech at economic policy symposium, Jackson Hole, Wyoming, August 26, 2022.


Moreover, a circularity likely exists between short- and long-term inflation expectations: During a period of high inflation, long-term expectations could very well be anchored because consumers and businesses expect central banks to hike aggressively to bring inflation back to target.


One nuance here: In 2011, amid a commodity price surge, the Fed ignored rising measures of short-term inflation expectations and didn’t hike interest rates. The likely key difference between 2022 and then: In 2011, the labor market was weak—far from conventional estimates of full employment. Thus we conclude that short-term inflation expectations are more or less important depending on other economic variables. If the labor market is at or near full employment, we believe it is important to closely track these expectations. Finally, we note that the European Central Bank (ECB), unlike the Fed, did hike interest rates twice in 2011. Yet those two rate hikes were very likely a policy mistake, one the ECB reversed in late 2011.


Sources: Congressional Research Service, Haver Analytics. Data as of March 2022.

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