Does inflation still matter?

Episode Summary

Executive Summary: The episode debates whether inflation still matters to investors in 2025. Both speakers agree it matters less than at the 2022 peak, but Mike Pond argues it remains important because core inflation is still above target, uncertainty and upside risks persist, and the Fed is likely to stay cautious. Key watchpoints are shelter inflation, tariffs, labor-market tightness, and dollar strength.

Main Topics: Does inflation still matter in 2025? (Priority: 5/5): The hosts revisit how investor attention has shifted from peak inflation panic to a more muted environment, while debating whether inflation has become irrelevant now that headline measures are near target. Fed reaction function and policy caution (Priority: 5/5): Even with headline inflation near 2%, the Fed still focuses on core measures, uncertainty, and the risk of inflation stalling above target, which keeps markets sensitive to each data print. Investor behavior and the fading inflation hedge trade (Priority: 4/5): Demand from cross-asset investors for inflation hedges surged during the pandemic but largely faded as inflation fears receded and TIPS fund assets normalized. Shelter inflation and measurement issues (Priority: 4/5): The discussion explores whether official inflation data overstates lived consumer experience because of imputed housing costs, but concludes investors must still follow the BLS and PCE/CPI measures used by the Fed. Tariffs as a 2025 inflation risk (Priority: 5/5): Potential tariff policy is identified as a major source of upside inflation risk, though the actual effect is uncertain and could range from meaningful inflationary pressure to little or none. Dollar strength and disinflation (Priority: 3/5): A stronger U.S. dollar could pressure import prices and help slow inflation, though pass-through to CPI and PCE is uncertain and depends on margins, contracts, and duration. Outlook for a choppy disinflation path (Priority: 4/5): The speakers agree inflation may trend lower over the year, but the path is likely uneven, keeping the Fed and markets attentive for several quarters.

Key Arguments: Inflation matters less than during the 2022 peak, but it still matters because the Fed has not declared victory and core inflation remains above target. Headline PCE at 2.1% is near the Fed’s goal, but core PCE and other underlying measures remain materially elevated versus pre-pandemic norms. Investor focus has shifted from direct inflation panic to indirect concern through Fed policy; inflation matters insofar as it affects rates and the timing of cuts. The Fed views inflation uncertainty as elevated and risks as skewed to the upside, which argues for continued policy caution. Shelter inflation may be the most important component for future disinflation, and private rent indicators suggest downside risk to official measures over time. Tariffs could add meaningful inflation pressure in 2025, with potential impacts ranging from roughly 40-100 bps depending on the policy scenario. A stronger dollar likely lowers import price pressure, but the transmission to consumer inflation is not guaranteed and may be slow or incomplete. Even if inflation trends down, the path is likely to be noisy, meaning markets may remain highly sensitive to monthly releases for some time.

Data Points: Headline PCE peak: 7.2% y/y - Mid-2022 peak mentioned as the point of maximum inflation concern. Headline CPI peak: 9.1% y/y - Mid-2022 peak cited alongside PCE as evidence of peak inflation. Headline PCE latest: 2.1% - September reading, only 10 bps above the Fed’s 2% target. Fed target: 2.0% - Official PCE inflation objective referenced throughout the discussion. Core PCE latest: 2.8% y/y - Latest reading cited as still elevated and above the pre-pandemic average. Core PCE vs 2012-2019 average: 120 bps higher - Difference versus the 2012-2019 period when core PCE never overshot 2%. Median/trim mean PCE gap: About 1 percentage point above pre-pandemic averages - Used to show underlying inflation remains sticky. TIPS AUM: Doubled early in the pandemic, then gave up most gains - Illustrates fading investor demand for inflation hedges. US dollar move: Broad trade-weighted USD up about 7% since August - Presented as a potential disinflationary force via import prices. Tariff impact estimate: About 1% higher inflation by year-end - If proposed 10% blanket tariffs and 60% China tariffs were implemented. Alternative tariff baseline: About half that, roughly 40-50 bps - Speaker’s more reasonable baseline for tariff-driven inflation. Shelter share of core CPI: Over 40% - Explains why shelter inflation is so important for the overall core inflation outlook. Shelter baseline forecast: About 3% by end-2025 - Expected to return near pre-pandemic norms. Potential shelter range: 1% to 5% - Speaker says this range would not be surprising, showing wide uncertainty. Owner’s equivalent rent pace: 5.3% annualized - Observed through the first eight months of last year, underscoring sticky shelter inflation.

Pivotal Quotes: "Ask an inflation market strategist whether inflation matters is a bit of an existential question. Obviously, I'm going to say yes." — Mike Pond: Opening exchange establishing the debate and acknowledging the speaker’s bias. "What these show is that, again, at least in the Fed's eyes, inflation uncertainty is still much higher than it was from 2012 to 2019, and risks remain decidedly to the upside." — Mike Pond: Used to justify why inflation still matters even near target. "The path to lower inflation is likely to be quite choppy." — Mike Pond: Summarizes the episode’s core forecast for 2025.

Implications: Inflation is no longer the market’s sole obsession, but it remains a key driver of Fed policy and rate expectations. Investors should watch shelter, tariffs, and labor data closely, as any reacceleration could keep the Fed cautious and prolong volatility.