Goldman: Still More Room For Front-End Inflation To Improve

Goldman Sachs note "earlier this summer, we highlighted the pronounced discrepancy between the near-term CPI path implied by the inflation market and our economists' inflation forecasts, recommending longs in front-end TIPS hedged with gasoline futures. Since then, this part of the inflation curve has widened significantly, taking our energy-hedged April 21 TIPS long recommendation towards our target. Next week brings the August CPI print, and while the rally has already taken the early 2021 implied CPI path about 80bp higher since the end of June—boosted most recently by the July release that saw the fastest core CPI rise since 1991 thanks to an ongoing rebound in sectors benefiting from the reopening economy—we think the repricing can extend further still. Cyclical pressures and rent freezes remain a source of potential downward pressure on inflation under our economists' forecast; however components such as apparel, hotel lodging, airfares, and financial services should provide some near-term offset, with that boost likely to strengthen post-vaccine. We suspect that the market is either overly bearish on the extent of the headwinds, underestimating those potential sources of upside, or some combination of the two, as even after the rally, the market-implied CPI path remains some 50bp below our economists' forecast by early 2021. We therefore maintain our existing recommendation, and revise the target higher by 40bp."