Inflation Will Offer Pleasant Surprise to Equity Markets

To some, the U.S. economy is on the verge of experiencing a sharp upturn in inflation that will force the Federal Reserve to accelerate the pace of interest-rate increases. The reality is that the balance of risks around inflation has normalized, which should be good news for equity markets that have been on high on alert for the prospect of an aggressive Fed.

Inflation is usually viewed on a trailing 12-month basis, which means that if prices move sharply in a particular month, the shock is carried over for the next 11 months before it drops out. This is relevant because energy prices were declining around this time last year, causing a drag on the inflation data. But now, a simple model that translates the current price of Brent crude oil to an estimate for the headline personal consumption expenditure index suggests that measure of inflation will rise to 2.5 percent by July before retreating. That’s higher than the Fed’s current projections.