Why Goldman Expects Inflation To Settle Down In 2022

If at first you don’t succeed.

Around this time last year, Goldman’s economic team projected core PCE inflation would exceed 2% in the spring of 2021, before ultimately receding in the back half of the year.

Needless to say, that call didn’t pan out, even as most of the bank’s other macro projections for this year proved to be a semblance of accurate.

Read more: How Goldman’s Inflation Call Went Wrong, According To Goldman

Goldman was hardly alone in getting the inflation call wrong. Virtually everyone else did too.

Of course, sundry armchair quarterbacks and legions of netizens who spend their weekdays pretending to be PMs on Twitter, all claim they nailed it. Remember: Telling your social media followers that inflation is likely to be more persistent than the Fed thinks doesn’t count as prescience. That’s just idle musing. Like telling your neighbor to bring an umbrella even though the weatherman said it’s going to be sunny today.

See, the thing about “nailing it” is, you actually have to make a prediction. A real one. You have to put a number to it. And then you have to say when, precisely, the relevant metric or data point will match that number. If you can’t do that, it’s not a prediction. That’s why most people don’t make actual predictions. Because it’s hard. When it comes to macroeconomic outcomes, it’s very nearly impossible.

It’s with that in mind that Goldman, in the 2022 vintage of the bank’s “10 Questions” year-ahead outlook piece, projected core PCE will fall below 3% next year, effectively putting the genie back in the bottle.

As a reminder, it’s at 4.7% now, just “slightly” above target. Do note the red arrows in the figure (below). As I put it earlier this month, I’m not sure how flexible “average inflation targeting” was supposed to be, but it’s probably fair to declare “mission accomplished.”

Core is the highest since 1989. Headline, at 5.7%, is the hottest in 40 years.

Goldman sees core falling all the way back to 2.5% by this time next year. The bank does expect a sharp rise in shelter inflation (there’s more on that here, for those interested), but noted that “travel services inflation is likely to fall as base effects drop out, medical services should decline as government payments end, and food services and accommodation should moderate as the flow-through from large wage gains while unemployment benefits were in place diminishes.” Ultimately, the bank sees PCE services inflation running at 3.75% by the end of 2022.

When it comes to goods, it’s obviously a matter of supply chain normalization. Goldman offered what I think it’s fair to describe as a cautious take — only to come to a relatively benign conclusion.

The bank’s David Mericle and Alec Phillips projected only a “slight” moderation in elevated durables demand. “Shortages and high prices have likely deferred some demand to next year,” they said, before describing the timeline on goods supply normalization as “hazy in the near-term” and projecting imbalances “well into 2023.”

So, how is that consistent with a benign outlook for inflation? Well, as Mericle and Phillips went on to explain,

As the goods sector transitions from an unusual environment of scarcity to a more normal environment of abundance and widespread availability, competition should bring prices down. This is the main reason we expect supply-constrained categories, which have gone from mildly deflationary to strongly inflationary, to run somewhat more deflationary than usual by late 2022 and 2023, shifting from a major boost to overall core PCE to a meaningful drag.

They also suggested any waning of the effect from surging commodities prices will exert downward pressure on headline inflation and, ultimately, core.

The figure (below) shows you the breakdown and projected moderation in core PCE.

All of that said, Goldman still thinks inflation is “likely to get worse before it gets better.” It’s possible that Omicron could introduce still more friction into disrupted supply chains and otherwise exacerbate the mismatch between supply and demand for goods.

At the same time, rising rents will start to bite as the surge in property prices works its way through to reported (i.e., official) inflation data.

Meanwhile, some media outlets are playing for web traffic over the holidays. “Big S&P 500 Bear Market Case Sees Inflation Finally Eating Everything,” an amusing Bloomberg headline declared. (Spoiler alert: It’s about margins.)