Don’t Rule Out Inflation Surprises yet, and Here’s How to Predict Them: Goldman Sachs

  • Inflation is beginning to moderate in developed markets, but potential data surprises remain a risk to investors.
  • Goldman Sachs suggests three areas that investors can watch in order to help predict these inflation surprises.
  • Commodity prices, currency movements, and regional inflation figures are key areas to look for future surprises.

Inflation is beginning to cool in the US and other developed markets as supply chain pressures slowly unwind and central banks’ interest-rate increases begin to take effect. 

But, according to Goldman Sachs, surprises still abound and can shock markets if too much bullishness is priced in.

“Given that central banks remain very focused on inflation data, inflation surprises are likely to remain a main driver of financial market swings for the foreseeable future,” Goldman Sachs economist Jan Hatzius wrote. 

Hatzius and other analysts offered three ways to anticipate such shocks, helping offset the negative effects of those surprises on an investor’s portfolio.

1. Look out for changes in commodity prices

Commodity prices can be a strong leading indicator for the rate at which the CPI changes, both for immediate costs like gas and food ingredients, as well as their role as inputs in other expenses like transport and other foods.

But Hatzius says despite that, they aren’t factored in enough by markets, with each 1% increase in food commodity prices associated with a larger 0.98 basis point inflation surprise, and a 0.29 basis point surprise from a 1% rise in oil prices. 

“This pattern suggests that many forecasters do not fully incorporate commodity price changes into headline forecasts, despite this information being available,” Hatzius said.

2. Check on how the country’s currency performed recently

Hatzius says local currency appreciation predicts downward surprises in headline and core inflation in the subsequent month. In other words, if the dollar rises in value one month, US prices rises should be expected to be lower than expected in the following month.

This is because a stronger currency reduces the prices of imports and other costs for items bought on international markets, with a 1% currency appreciation being associated with a one basis point larger downward headline surprise, according to Goldman.

“These patterns — which are similar to our findings for commodity prices — suggest that consensus forecasts also do not fully incorporate the lagged effect of realized FX movements on inflation.”

3. Look to the countries that release inflation figures earliest

Adding to commodity and currency movements, it can help to closely monitor inflation patterns in countries geographically close to the ones you’re monitoring. 

Economies within regions share more interdependencies in their supply chains, labor practices, and pricing structures, so are likely to be affected by the same cost pressures that feed into CPI.

Goldman’s analysis found strong links between the US and Canada, the euro area flash estimate and the rest of Europe, and the Thailand CPI print and the rest of Asia.

“The significant slowdown in global headline and core inflation that we anticipate in 2023 will likely eventually lower market sensitivity to inflation surprises,” Goldman analysts wrote. 

“Until then — as well as in any future periods when sensitivity to inflation surprises is very elevated—these three factors can provide valuable information that helps lower uncertainty and predict market reactions ahead of inflation releases.”

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