Bradley Rogoff: Hello, and welcome to the first flip side of 2025. I'm Brad Rogoff, Head of Research at Barclays. And today I have Mike Pond with me. And we're going to be diving into a crucial question for investors. Does inflation still matter?

Michael Pond: It's an interesting question, Brad, and one I think about daily as Head of Inflation Market Research at Barclays.

Bradley Rogoff: That's right, Mike. Your job is inflation. You always have cared about inflation. I started as a credit guy, and I have to admit, I didn't pay much attention to inflation for a large part of my career. Post pandemic, though, you became the most popular person in the office. But I think considering how much inflation, if we measure it by CPI or PCE, has come down, I'm not sure how much it should matter to markets in 2025.

Michael Pond: So I'll be the very first to acknowledge that I have a vested interest here. Asking inflation market strategist whether inflation matters is a bit of an existential question. Obviously, I'm going to say yes.

Bradley Rogoff: I didn't mean to question your livelihood, Mike.

Michael Pond: Well, that's a relief. But I think I'm secure enough to give an unbiased answer, which is still a yes, but a qualified one. Clearly, it matters much less than it had when headlined PCE and CPI peaked at 7.2% and 9.1% year over year in mid-2022. Back then, inflation was the front burner issue for most market participants. It is still important, but admittedly, just as peak inflation has passed, so has peak interest in inflation and inflation markets.

Bradley Rogoff: I totally agree that context is important, right? We always got to put things in context. However, inflation hasn't come down only slightly from the peak as we were just alluding to. Headline PCE, which is what the Fed officially targets, has dropped all the way to 2.1% in September, only ten basis points higher than the 2% goal. So with inflation basically back to the Fed's target, you know, even with little bounces here and there, it should no longer be that important to investors, particularly the non-TIPS crowd that you know hang in more often.

Michael Pond: Good point. But investor interest in inflation is twofold in my view. During the pandemic we saw significant interest in the inflation market from what I call crossover investors though others might call them tourists from equities, credit, munis, et cetera.

Bradley Rogoff: Personally, I enjoy being a tourist. But to your point, and those who know me well know I typically do not go back to the same place being a tourist very frequently.

Michael Pond: Well, these particular tourists were worried about what high inflation might do to returns in their risk on portfolios, and they use the inflation market as a hedge. But once peak inflation fear passed, those hedges were mostly all taken off. We can see this, for example, by looking at TIPS focused mutual funds and ETFs. Their assets under management doubled in the early pandemic years, but they have since given up most of those gains. Interest in the inflation market from these types of investors has all but gone away. However, this is not so when talking about a focus on inflation itself.

Bradley Rogoff: I'm kind of going to go with the actions speak louder than words thing here from what you just said. So if inflation risk isn't high enough to buy insurance via hedge in the inflation markets, then investors clearly aren't obsessing over it.

Michael Pond: But they're obsessing about the Fed. And the Fed still cares very much about inflation. So there's been a shift from a direct concern about sky high inflation to an indirect one via the monetary policy outlook.

Bradley Rogoff: Okay, fine. But investors cared about the Fed before the pandemic, but they were not concerned with each inflation print. My view is that we could get back to that regime this year.

Michael Pond: I don't agree, and there are three main reasons for that. First, while the Fed does target headline PCE, which has come down almost to their target, core measures are seen as better indicators of the underlying trend in where inflation is headed. And those remain elevated and are expected to stay above 2%. Core PCE was up 2.8% year over year in the latest reading. That's 120 basis points above the average from 2012 to 2019, a period where it never overshot 2%. Other measures of underlying inflation, such as median PCE and trimmed mean PCE, are also about a percentage point above their pre-pandemic averages. So yes, inflation has come down, but it's still high compared to the decade between the global financial crisis and the pandemic. And the Fed still seems very far away from declaring victory.

Bradley Rogoff: I get that that's a big move. But could I make the argument that inflation was a bit lower than optimal pre-GFC and now it's a bit higher? Both could work. So I don't understand what's making investors so afraid.

Michael Pond: It's the Fed policy reaction function that is really the answer to your question. The concern I hear from investors is that progress on inflation has stalled. And unless the US consumer slows and labor markets cool, more significantly, inflation could be stuck not at 5% or 6%, but at a level that is just high enough that it keeps the Fed from cutting and rates from coming down. One risk factor that fuels this concern is the potential for labor markets to remain tight if immigration slows on more restrictive border policies.

Bradley Rogoff: Okay. So that's clearly one of your points. But you said earlier there were three reasons why you don't think we're in that old regime. Talk us through the others.

Michael Pond: Well, one is uncertainty and the other is the Fed's perception of the skew of risks in the outlook for inflation. You have to scroll all the way down to the bottom of the Fed's Summary of Economic Projections to find it, but they provide diffusion indices on participants assessments of risks to the baseline inflation outlook and uncertainty around it. What these show is that, again, at least in the Fed's eyes, inflation uncertainty is still much higher than it was from 2012 to 2019, and risks remain decidedly to the upside.

Before the Fed had a numerical target of 2% on PCE, Chairman Greenspan used to describe their objective as having inflation low and stable enough that it wasn't a consideration when making economic decisions in the years leading up to the to the pandemic. We were there. Remember, Flexible Average Inflation Targeting, so FAIT was introduced because the Fed couldn't generate enough inflation currently though, at least for the Fed, underlying inflation is still too high, risks are to the upside and uncertainty is elevated. We are far from Greenspan's definition.

Bradley Rogoff: You've got some good data points in there, something I expect from someone who lives and breathes inflation, but isn't one of the reasons that core and other measures remain high. The shelter component which uses rents. So we in fact know that that's not what most consumers are actually experiencing, though, when it comes to housing.

Michael Pond: Well, we could probably do a full podcast on just this question alone, or more broadly, on whether inflation is measured correctly by the BLS and matches consumer experiences. My quick answer, though, a mantra really is that ours is not to reason why. Ours is just to understand the CPI and of course the PCE. As an aside, then, Chairman Bernanke used to say that one of the reasons why he preferred the PCE over the CPI is because a large share of housing CPI is imputed. It is, and I quote him, essentially made-up numbers. So Brad, you're in very good company to question it. That said, if the inflation markets and the Fed follow these measures, then so should we.

Bradley Rogoff: Look, those who are listening to this and like me, aren’t inflation guys, might feel like this is a ploy from the inflation people to just stay relevant because I don't love the “it is what it is” answer. But I do understand we can't ignore what the Bureau of Labor Statistics gives us. However, technology is improving and we can get more private measures which historically have led the BLS data by a few quarters. These show that rent inflation has come down considerably. And shouldn't we be seeing this downward trend in CPI and PCE soon as a result of that. And if so, shouldn't investors look through high current numbers from the BLS if they know what's ahead?

Michael Pond: You make a really good point, and I think there's a reason for investors to be cautiously optimistic when it comes to the outlook for shelter inflation. Here's why I'm cautious, though. In late 2022, more than two years ago, in the speech that got investors to focus on the "super" core measure of core services at shelter. Chair Powell similarly noted the decline in inflation for new leases implied by private indicators, as a basis for his outlook that BLS measured housing services inflation would begin to fall sometime in 2023. That forecast ended up being very wrong, at least from a magnitude perspective. Owner's equivalent rent was still rising at a 5.3% annualized pace through the first eight months of last year, so caution is warranted. And last year we were actually highlighting the risks that shelter inflation would stay high, just as it did.

Bradley Rogoff: Well, that wouldn't be the first forecast of the Fed, or even sell side research, has gotten wrong.

Michael Pond: That's very true. But as I said, there are reasons to be optimistic as well. We believe that BLS measures have held up higher than other indicators of rents because they have a higher weight to renewals and single-family rentals where inflation has stayed high, whereas most private indicators are heavily weighted towards new leases for multifamily rents. We're now seeing inflation for renewals and single-family rentals fall below pre-pandemic trends. So in our view, the risk to the shelter outlook, which make up over 40% of core CPI, has swung from upside risk to downside risks. Our baseline for the end of this year is about 3%, which is what we were seeing pre-pandemic. However, we'd be less surprised at 1%, than 5%.

Bradley Rogoff: All right. I'm feeling pretty good about my argument. Now, the biggest component heading in the right direction. And I get that the Fed cares about inflation, but they also care about growth. And there have to be other inflation risks that are more concerning than obsessing over the number after the decimal point in CPI or PCE in 2025.

Michael Pond: Absolutely. And hands down, it's the potential for tariff induced inflation that investors should focus on in our view. That factor alone provides a 100-basis point error band for 2025 inflation. We estimate that if campaign trail rhetoric of 10% blanket tariffs on global imports and 60% on those from China were to be enacted, as policy inflation readings would be about 1% higher by this yearend than they would be without any tariffs at all.

Bradley Rogoff: Okay, but I don't just look at inflation markets. I look across all markets and they don't seem to be pricing in tariffs that high.

Michael Pond: Even so, we have argued that a baseline of about half that is more reasonable, but even 40 or 50 basis points is significant. As a result, we are still forecasting core CPI year over year to have a three handle in mid-2026. However, just looking at what happened during the first Trump administration where there was little evidence of tariff induced CPI or PCE inflation, a zero impact is also a plausible scenario. There is considerable tariff uncertainty in both directions, and we'll be watching tweets like everybody else. But this seems to present another downside risk, at least compared to our baseline and what we think the markets have priced in.

Bradley Rogoff: Okay, but the first Trump administration, there were tariffs and they were implemented but they were quite targeted to specific goods industries and countries. The result was that there were micro stories important to certain investment sectors, certainly. But it never really became a macro story and significant for growth or inflation. The same time, there's already been a significant move in the US dollar. The broad trade weighted USD is up about 7% since August, and some of that's positioning ahead of tariffs maybe, which may or may not happen once again. But I would argue we get downward pressure on import prices and hence good price inflation as a result of this currency move independent of the tariff impact.

Michael Pond: You make a very good point. Whenever we do analysis between US dollar moves and import price inflation we find a very strong negative relationship. However, and this is where I would caution again, the pass through into consumer inflation as measured by CPI and PCE is less clear. Currency moves usually need to be large enough not to be absorbed in margins, and sustained long enough to last beyond contracts which are already in place. The same is true with other inputs such as shipping costs, tariffs and fuel costs. So whether inflation will slow or not as a result of the currency move is still very much up for debate. But you're right that the direction of risk is clear. A stronger dollar increases the likelihood of inflation slowing further.

Bradley Rogoff: So my takeaway here is you think there are upside risks to inflation from growth in labor markets. But downside risk from shelter and the USD and from tariffs at least compared to what was discussed on the campaign trail. Am I getting that right?

Michael Pond: Correct. But I would emphasize two things. First, there remains a high degree of uncertainty, which is likely to keep the Fed quite cautious in removing restrictive policy. Some clients we speak with even think the next move is a hike. And second, while overall we think downside risks to inflation outweigh upside ones, the path to lower inflation is likely to be quite choppy. So a year from now, inflation could come down enough that we might be back to that pre-pandemic regime where most investors do not care much about the details of each inflation print. But between now and then, the Fed is likely to be quite sensitive to each reading, and hence markets will as well.

Bradley Rogoff: All right, Mike, I'm going to concede that your job is probably secure for a few more quarters at least. But if we don't get tariff induced inflation later this year and shelter inflation comes down, as we were talking about, it seems like growth needs to remain very strong for inflation to still be relevant a year from now. For now, though, that is all the time we have so clients can read our latest thoughts on the macro-outlook in our Q1 global outlook titled Glass Half Full, available on Barclays Live.