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The risks of “underinflation” to the US economy are decreasing

The risks of “underinflation” to the US economy are decreasing

“The base scenario for the US economy remains ‘weak inflation’ – that is, below-average growth accompanied by above-average inflation. At the same time, scenarios of stronger growth and lower inflation than we predicted just a few months ago are becoming more likely. Our latest analysis increases the likelihood US GDP growth has slowed to a trend of 1.5% to 2.0% annually, instead of the 0.5% we expected at the start of the year.

Core inflation is now heading below the Fed’s year-end estimate of 3.9%. In July, commodity prices fell 0.3% month-on-month as supply chains returned to normal, commodity demand slowed and Chinese commodity prices fell. Conversely, prices for basic services (excluding housing) increased by 0.3% month-on-month in July. Service prices primarily reflect the balance between labor supply and demand, and the 12-month moving average of labor supply is now close to the level of labor demand. This indicates that inflation in the services sector will also decline.

The two remaining risks to inflation are the evolution of rent and energy prices. Rents have been a “stubborn” component of service inflation since 2021, but recent data suggests there are signs of slowing down here as well.

Energy demand will catch up and possibly overtake energy supply in the third quarter of this year. This unstable balance may be disruptive and draw the attention of US policymakers to the geopolitical situation in the Middle East.

However, economic growth in the United States is slowing down. Growth in hours worked, an indicator of economic activity, fell to 1.3% from more than 2.5% year-on-year.

However, falling inflation and higher nominal wages raise real wages. Consumer confidence is on the rise and US consumption is strong. Public investment and technology can support a sustainable recovery in productivity.”

from Dalip SinghAnd Chief Global Economist at PGIM Fixed Income

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