E-piphany

This is a single issue, of the August 2025 Quarterly Inflation Outlook.

The QIO is a 15-20 page quarterly discussion of current topics in inflation, including underlying dynamics, valuation, and related markets.

Executive Summary

• Where is the recession? We suggest that the asynchronous nature of the goods economy and the services economy since COVID has resulted in more-stable growth and more-stable inflation than it otherwise would have been. This is not a permanent condition, and we believe the economy is re-synchronizing.
• The biggest risk to the economy and markets right now is the risk that (non-policy) interest rates might be forced higher to balance dollar demand as the trade balance shrinks, the Fed’s balance sheet shrinks…but the budget deficit does not shrink fast enough to balance.
• We mention various policy moves that, if timed well, could reduce that possibility but when large changes to flows happen over a short period of time before balancing transactions can happen, breakage can occur.
• Insurance costs appear in three places in the CPI (and indirectly in a few others). In each of these places – Tenants’ and household inflation, Motor vehicle insurance, and Health insurance – increases will be additive to inflation in 2026.
• Cost-cutting at the BLS, resulting in more imputation and other alternate estimation methods, will not meaningfully affect the accuracy of the CPI. We explain and illustrate.
• Adding USDi to the menu of portfolio securities improves portfolio outcomes in important ways. We explain.
• Because the tariffs effect is being spread out over a longer period than expected, we nudge down 2025 forecasts slightly and maintain them for 2026 as we describe the balance of risks.
• Inflation markets are reasonably balanced but the equity market is dangerously overvalued with few ways that events can unfold in a way that will surprise positively.