Goldman Sachs: U.S. Inflation is Shifting from Localized to Widespread, but Far from Repeating the 2022 Crisis

Expectations for interest rate cuts have cooled, with the probability of a rate hike in September rising to over 50%.

Written by: Bu Shuqing, Wall Street Insights

Goldman Sachs warns that the risk of inflation spreading in the U.S. is now higher than the historical average, but it is far from the levels seen during the 2022 crisis. Currently, price increases are mainly concentrated in a few high-weight sectors, and housing inflation is expected to continue cooling. The market has begun to bet on a rate hike by the Federal Reserve in September, with inflation trends remaining the biggest variable in the second half of the year.

The risk of inflation spreading in the U.S. is becoming a reality, but the extent is far from crisis levels.

Goldman Sachs economist Jessica Rindels' latest research shows that, measured by the Federal Reserve's preferred inflation indicator, the Personal Consumption Expenditures (PCE) index, the current breadth of inflation is already above the historical average from 1990 to 2019, particularly notable under a weighted measure. This conclusion echoes the concerns expressed by new Federal Reserve Chair Jerome Powell during last week's congressional hearing, where he explicitly listed preventing localized price increases from "spreading broadly" as one of his top responsibilities.

However, Rindels' research also provides an important reference point: on a custom quantitative scale from 0 to 10 (0 corresponding to the 1990 to 2019 average, and 10 corresponding to the peak inflation of 2022), the current breadth of inflation under the weighted measure is 6, while the unweighted measure is only 2, both far below the extreme levels seen during the pandemic. The market's reaction has been relatively calm, with S&P 500 futures rising about 22 basis points before the market opened on Monday.

Quantitative Framework: How to Measure the Degree of Inflation Spread

Rindels employs a triple-filtering method to construct her analytical framework:

Using PCE as the primary data source, she smooths short-term fluctuations with a six-month annualized change rate and conducts statistics under two measures: weighted by the weight of each component in the PCE and unweighted by category.

Within this framework, the breadth of inflation is defined as the proportion of categories within the PCE that have increased by more than 3%. A weighted reading of 6 means that, based on consumption weight, the current degree of inflation spread is close to 60% of the peak level in 2022; while the unweighted reading of only 2 indicates that price increases are still relatively concentrated in terms of the number of categories and have not spread broadly.

The significant difference between the two measures indicates that current inflation pressures are mainly concentrated in high-weight consumption categories rather than being evenly distributed across various sub-sectors.

Price Increases Concentrated in Audio-Visual, Financial, Medical, and Transportation

Rindels' research points out that the fastest rising prices are concentrated in four major categories: video/audio services, financial services, medical services, and air travel/transportation.

These categories have a high weight in the PCE and are the main sources pushing the weighted reading higher.

In contrast, while housing rents remain an important component of inflation, Rindels predicts that their impact will gradually diminish—expecting that by the fourth quarter of this year, the increase in housing rents will fall below 3%, at which point their contribution to the overall breadth of inflation will significantly weaken. This prediction provides the market with a certain signal of easing prospects.

Market Pricing: Expectations for Rate Cuts Cool, Probability of Rate Hike in September Rises to Over 50%

Powell's congressional hearing last week was widely interpreted by the market as having a hawkish tone.

Subsequently, the yield on the U.S. 2-year Treasury bond slightly retreated from nearly 4.3% to 4.18% on Monday, indicating that the market adjusted after digesting his statements.

According to CME FedWatch data, traders currently expect an 85% probability that the interest rate will remain unchanged at the July meeting, but the probability of a 25 basis point rate hike in September has risen to 52%. This means the market has incorporated an additional rate hike into the baseline scenario, and the persistence of inflation spread is reshaping expectations for the Federal Reserve's policy path.

For investors, the core contradiction in the current situation is that while the breadth of inflation has exceeded historical norms, it has not yet triggered systemic risks; expectations for policy tightening are rising, but the pace remains uncertain. Whether housing rents can cool as expected will be a key variable in observing inflation trends in the second half of the year.

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