US inflation: Complacency vs emerging upside risks

Key takeaways

• US inflation data currently presents a mixed picture, but market pricing suggests little concern.
• Recent goods inflation prints have been surprisingly benign, but leading indicators suggest pressure to come.
• Services inflation has come in materially above seasonal norms in recent months.
• Early signs that employment conditions are tightening again could lead to wage pressure building. 
• US Treasury Inflation-Protected Securities owned over US conventionals, protecting us against US inflation coming in ahead of expectations.

US inflation data currently presents a mixed picture, but market pricing suggests little concern. One-year inflation swaps imply ~2.1% inflation over the next 12 months, effectively embedding a benign outcome. In our view, this leaves little room for a downside surprise, particularly given a number of emerging pressures beneath the surface.

US 1-year inflation swap 

Source: Bloomberg

Goods inflation: Calm today, pressure building

Recent goods inflation prints have been surprisingly benign. Tariffs have had limited observable impact, and the Middle East conflict did not push goods prices meaningfully higher; indeed, prices fell relative to seasonal norms. This resilience has reinforced the market narrative that goods disinflation remains intact.

However, forward-looking indicators paint a more cautious picture. Supply chain pressures are clearly rebuilding, and leading indicators of goods inflation have turned higher. Since 2019, US goods inflation has shown a strong relationship with China’s Producer Price Index (PPI), which has recently been accelerating, partly driven by higher energy costs. While this could reverse if oil prices normalise, it nonetheless introduces upside risks to inflation.

China PPI, US core goods & oil prices 

Source: Bloomberg

Additional pressures are emerging in specific categories. Rising memory prices and selective price increases in technology goods (e.g. recent pricing actions from Apple and Microsoft) suggest latent inflationary forces, even if they have yet to appear meaningfully in official data. Overall, while current data remain benign, the balance of risks for goods inflation appears skewed toward higher inflation.

Services inflation: Broadening pressures beneath the surface

Services inflation, which represents ~60% of CPI, remains the critical battleground. Shelter, around 35% of headline CPI, and 58% of core services CPI, should continue to mechanically pull inflation lower as leading rental indicators feed through. This has been a key disinflationary force for the past two years.

However, outside shelter, the picture is more concerning. Core services inflation has come in materially above seasonal norms in recent months, with broad-based acceleration across categories. Notably, this has occurred despite services being less directly exposed to commodity shocks, raising the possibility that firms are using external shocks (e.g., the Middle East conflict) as an opportunity to push through price increases.

The labour market adds a further layer of complexity. There are early signs that employment conditions are tightening again: unemployment appears to be rolling over, payroll growth is stabilising, and indicators such as hours worked and job leavers are improving. Historically, these have been leading indicators of wage growth.

While the small business compensation index has already turned higher, typically a leading signal for wages, this has not yet been confirmed by broader measures such as Indeed wage growth. If confirmed, this would represent a meaningful upside risk to services inflation over the next 12 months.

Employment cost index & services inflation YoY 

Source: Bloomberg

Macro backdrop: A recipe for persistent inflation

Beyond near-term dynamics, the broader macro environment remains inflationary. The US economy continues to benefit from:

• Large fiscal deficits (~6% of GDP)
• Significant capital expenditure from hyperscalers (~3% of GDP)
• Labour supply constraints due to the immigration clampdown
• Ongoing investment in onshoring, defence, and industrial capacity.

This combination of strong demand and constrained supply is not typically consistent with sustainably sub-2% inflation. As such, absent a cyclical downturn, the current environment appears more aligned with persistent inflation than a return to pre-pandemic norms.

Headline inflation leading indicators & US CPI

Source: Bloomberg

Conclusion: Asymmetric risks

In summary, while near-term inflation data may be reassuring as pressures caused by the Middle East unwind, a range of forward-looking indicators suggest the risks are shifting. Goods inflation appears benign but fragile, services inflation is showing signs of broadening, and the macro backdrop remains supportive of price pressures.

With market expectations already anchored back to target, largely thanks to hawkish commentary from Kevin Warsh, the new Fed chair, the asymmetry is clear: it will require a near-perfect disinflationary outcome to validate current pricing, whereas only modest upside pressure would challenge it.

Given this, we currently have no exposure to US conventional government bonds and hold only US Treasury Inflation-Protected Securities (US TIPS) in the W1M Multi-Asset Funds and MPS, ensuring we have some protection should inflation come in above expectations.

Glossary

• Inflation
  The rate at which prices for goods and services rise over time, reducing purchasing power.
• Consumer Price Index (CPI)
  A key measure of inflation tracking the average change in prices paid by consumers across a basket of goods and services.
• Producer Price Index (PPI)
  Measures price changes at the wholesale/producer level; often leads consumer inflation, particularly for goods.
• US Treasuries 
  Standard US government bonds with fixed interest payments, sensitive to inflation surprises.