Why These 2 Wall Street Economists 'Not Too Concerned' By January's Hot Inflation, Maintain Prediction For May Rate Cut

Despite a pair of unexpectedly high inflation reports last week, Goldman Sachs analysts Spencer Hill,CFA and Ronnie Walker maintain their outlook for a steady return to the Federal Reserve’s 2% inflation target and anticipate rate cuts as early as the first half of this year.

In a note shared Monday, Hill and Walker said that they are “not too concerned” about the robust figures presented in the January Consumer Price Index (CPI) and Producer Price Index (PPI) reports. They argue that January’s price changes often display cyclical volatility, a phenomenon they refer to as the “January effect,” which typically sees a deceleration in inflation rates by February.

The OER’s Surprise

A notable surprise for the analysts was the 0.56% spike in owners’ equivalent rents (OER), marking the most significant divergence from the primary rent measure since 1995. Given that OER constitutes a substantial portion of core CPI (34%) and core PCE (13%), its impact is significant.

“The largest component of the CPI—owners' equivalent rent, or OER—tracks a price that nobody pays: an imputed rental payment from homeowners to themselves,” Goldman Sachs wrote.

Goldman Sachs highlights that OER surged, likely due to a rebound in the housing market coupled with a pronounced affordability gap between buying and renting. This discrepancy has redirected potential buyers to an already strained rental market.

The January’s Effect

The recent CPI report also underscored the January effect, with several labor-intensive services categories witnessing price adjustments at the start of the year. This adjustment is seen as a realignment of prices in response to the cost pressures experienced in 2023.

Despite the volatility in January’s data, Goldman Sachs anticipates that these fluctuations will not significantly alter the inflation trajectory for the rest of 2024, leading to a modest increase in their core PCE forecast for the year.

Fed Rate Cut In Sight

Looking ahead, Goldman Sachs stands by its prediction of a rate cut in May, based on the January FOMC statement suggesting rate reductions could occur once inflation shows a sustainable movement towards the 2% target. If inflation trends align with the analysts’ projections, core PCE inflation could decrease to 2.5% by the May meeting, with expectations for further declines in the following months.

Consequently, Hill and Walker are forecasting a series of five 25 basis point cuts in the Fed funds rate throughout the year, starting with the May meeting.

However, they note that the upcoming February CPI and PPI reports will be crucial in confirming whether the January increase in OER and non-housing services inflation was indeed temporary.

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