BNY\u2019s John Velis and David Tam argue elevated US \u201csupercore\u201d inflation remains the central case for further tightening, even as they still lean towards a July hold. Since mid-2023, core services inflation ex shelter has been running at nearly 1 percentage point above its pre-Covid pace, yet they describe it as steady rather than accelerating. They also point to transport services, especially airfares linked to the energy shock, alongside health care costs tied to rising insurance premiums and reduced Obamacare subsidies, plus financial services, as key sources of persistence.<\/p>\n
They quantify that transportation and health care together account for 0.7% of a 3.0% increase in supercore, and argue these areas are not especially responsive to tighter monetary policy. Separately, Chair Kevin Warsh\u2019s Inflation Frameworks Task Force is set to reassess inflation drivers and \u201cfirst principles\u201d, including alternatives to headline PCE such as trimmed mean inflation. They note trimmed mean lagged core y\/y PCE after Covid, but could also lag disinflation; for example, headline inflation fell quickly in late 2008, while the Dallas trimmed mean did not show a similar decline until mid-2009.<\/p>\n
As derivative traders, we should position for a policy hold at the upcoming Fed meeting, even as sticky inflation remains a major talking point. Short-term interest rate futures are currently pricing in high odds of a pause, which aligns with our near-term outlook. While some hawkish rhetoric might spark brief volatility, we expect the central bank to keep rates steady for now.<\/p>\n
The main argument against a pause is “supercore” inflation\u2014core services excluding shelter\u2014which is running nearly a percentage point above its pre-pandemic baseline of about 2.2%. However, much of this heat is driven by sector-specific costs like airfares and rising healthcare premiums, which do not react quickly to interest rate hikes. To exploit this, we recommend using options on inflation swaps to hedge against the risk that these stubborn components keep medium-term yields elevated.<\/p>\n
We must also watch Chair Kevin Warsh’s new Inflation Frameworks Task Force, which is reassessing how the Fed measures price stability. Warsh\u2019s preference for trimmed mean inflation could alter the path of monetary policy because this metric filters out volatile prices and tends to lag during disinflationary periods. Historical data shows that after the 2008 financial crisis, the Dallas Fed Trimmed Mean PCE took almost nine months longer than headline inflation to reflect a downward trend. <\/p>\n
If the Fed shifts toward this trimmed mean framework, rate cut expectations for the end of the year will likely be pushed back. We suggest traders initiate bear flattener positions in the Treasury yield curve to profit from a “higher-for-longer” environment. This positioning protects our portfolios against a Fed that remains hawkishly biased, even as headline inflation numbers appear to cool.<\/p>\n\n\n\n