Goldman: Common Factor Dominates Compression In G3 Traded Inflation

Goldman Sachs note that they have “highlighted the selloff in US inflation since the May US CPI print, noting that the market has priced for a sharp deceleration in inflation over the coming year or so. That move in inflation forwards since the first half of June has been decidedly global in nature, reflecting intensifying growth concerns. A principal component analysis on G3 inflation forwards shows that the recent first principal component (PC1) decline was the second largest since 2013 (outside of the COVID shock) and explains the bulk of the traded inflation compression across markets. Despite the role of supply constraints in driving up realized inflation, the common factor across G3 inflation forwards has been strongly correlated with demand-induced changes in oil prices since early 2020 (which we use as a forward-looking proxy for global aggregate demand expectations); much of the recent global compression in traded inflation has occurred alongside a substantial demand-induced oil drawdown. While the above suggests that improved growth sentiment could support a recovery in global inflation forwards, so long as the Fed and ECB maintain their inflation emphasis, the extent of any global traded inflation rebound is likely to be limited.”