Leading indicators suggest a final wave of disinflation in 2025, driven by weakening shelter inflation and a cooling housing market. This scenario could lead to a dovish Fed stance and rally in fixed income.
Our Leading Inflation Indicator suggests a final wave of disinflation might occur in the first half of 2025. This recent dip is primarily driven by leading indicators of shelter inflation, which comprises over 30% of the core US inflation basket. Official shelter inflation data typically incorporates on-the-ground rent growth with a lag due to its methodology. Alternative series, such as the Zillow Rent Index, have been utilized to predict future shelter inflation trends.
One of the most reliable predictors of shelter inflation is the CoreLogic single-family rent index, which recently reached its lowest level in 14 years.The housing market is showing signs of weakness, supported by other leading indicators. During the pandemic, housing demand surged, but supply chain issues and labor shortages prolonged the construction cycle, resulting in significant backlogs that sustained the market. Big US homebuilders like D.R. Horton now report backlogs returning to 2019 levels, suggesting this tailwind is waning. The construction sector plays a crucial role in the US business cycle, and its cyclical weakening often signals a broader softening in US growth. Data points on inflation, growth, and the housing market indicate that a disinflationary slowdown in growth might be on the horizon. This scenario would likely lead the Fed to adopt a 'proactive risk management' dovish stance, easing financial conditions.Stocks and bonds could rally, presenting an attractive risk/reward profile for fixed income. The market anticipates the Fed to remain on hold in March, potentially delivering two rate cuts this year before halting further adjustments. Given the relatively low probability of Fed hikes as long as Powell remains Chair until May 2026, bonds offer an intriguing risk/reward proposition if my disinflationary thesis holds true
DISINFLATION BOND MARKETS FED POLICY HOUSING MARKET ECONOMIC SLOWDOWN
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