Dear Valued Clients and Friends,
I am very glad I did not finish writing Dividend Cafe on Thursday this week, as the GDP number released Friday morning is highly relevant to today’s Dividend Cafe. For those who missed it, the annualized GDP number came in at +1.4% for Q4, significantly lower than expected. The subject of today’s Dividend Cafe was already going to be economic concerns, and the GDP number just added a little more headline sizzle to what was already going to be an important Dividend Cafe. It is even more important now.
As I was about to submit this Dividend Cafe for release, the Supreme Court did indeed strike down President Trump’s use of IEEPA to implement tariffs. I assure you, I will have a lot more to say about this in the Monday Dividend Cafe.
So with all that said, in this week’s Dividend Cafe:
- I will evaluate what bond markets have been telling us for quite some time about inflation, prices, and most importantly, economic growth.
- I will look at where things stand with the price level, and why disinflation is a likely near-term outcome, but with crucial caveats galore.
- And I will look at why a worse underbelly to disinflation lingers, that while not fully assured, could leave people surprised at how the economic data and political spin create more confusion than ever.
Let’s jump into the Dividend Cafe …
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The Case for Lower Inflation
As I am typing, the 10-year bond yield is at 4.07%, about 10 basis points lower than where it started the new year and more than 50 basis points lower than where it started the prior year. As I type, the 5-year inflation breakeven rate is 2.43%. It has spent most of the last three years between 2.1% and 2.6%. This is a market pricing of real-life inflation expectations (as the 5-year TIP yield is subtracted from the 5-year treasury yield; the TIP yield is what inflation-protected treasuries are actually trading for in the market; there is no indicator like a price indicator, and there is no price indicator, like a multi-trillion dollar bond price indicator).
If the absolute inflation rate, the one that comes out each month in what they call a CPI, were to start printing something higher, and higher, and higher, even if just 0.1% per month for a few months, it would likely be very problematic for the Trump administration, politically. I do not expect that to happen, but if it did, the cosmetics of it would be very problematic. However, that does not mean the CPI going down 0.1% here and another 0.1% there is going to help, either. In the haste to politicize inflation, everyone involved has made a mockery of both math and how consumers feel about prices. An inflation rate that goes from 2.6% to 2.4% allows political spinners to say one thing, and it is for good reason, but it doesn’t allow for someone paying prices they felt were high to now feel like they are paying less (because they wouldn’t be, in that scenario). And when you add that the vast majority of “felt” inflation is in housing prices and rent prices, you basically have a slew of “economics” (data, math, mixed signals, how things are calculated, headline numbers) that have nothing to do with the “politics” of it (how a voter feels relative to what they expected).
I want so badly to say, “I do not care about the politics of this – I am fully deaf to the spin from both sides – and my entire focus is on real-life economic analysis that matters, not soundbites that serve a political moment.” And if I said those things, they actually are pretty much true in real life when it comes to me and this subject … But I can’t say it, or shouldn’t say it, because despite my commitment to those things, the rest of the world is going to pick their spots for convenient, selective focus and dialogue, and I think it’s mostly going to continue to be intolerably stupid.
But there is one exception to this. The “rest of the world,” except the bond market. The bond market doesn’t care about political narratives. And it is my belief that there is a double-cross coming that is going to defy political logic, make perfect sense in market logic, and have a lot of relevance to the real economic picture in which we live.
I think “disinflation” is coming, and I don’t think people are going to like it. But there is a chance I am really wrong on one part of this.
Wait, “Dis”inflation? What about Today’s PCE?
I am not going to do what my prior paragraphs just rejected, and I am about to write a Dividend Cafe suggesting that disinflation is coming this year, but not for reasons that should be (or will be able to be) politically celebrated. But it is certainly fair to ask, given the premises I have put on the table, what in the world I am talking about, given today’s report. The Commerce Department’s Bureau of Economic Analysis released the December core PCE number today (Personal Consumption Expenditures), and it was hotter than expected at +0.4%. For the calendar year of 2025, the core PCE was +3%, which I should point out was higher than the +2.9% of calendar year 2024. If you add food and energy (headline vs. core), it does not get better … Food prices were up +0.4% on the month and energy prices were up +0.2%. And this is all for December … the January number (headline) will likely be worse as heating costs, crude oil, and natural gas all flew higher in January.
Expectations for January’s price data are now at +0.4% on the month, which would move the year-over-year addition to +3.1%. The Producer Price Index data will give me a better feel for how wholesale prices are evolving and what pass-through effects are realistic
This doesn’t sound good.
So why would I argue that there will be disinflation in the data but not in a way that allows for political bragging?
Because the data is about to show higher prices in goods (which have gone from 0% y/y increase to +1.7% increase over the last year), even as the total number is about to capture (at long last) the reality of rental cost deflation. The sheer weighting of the latter category (especially in the CPI number) will allow for a lower total inflation number, even as certain goods, insurance, and tariff-sensitive items continue to be higher-priced.
The fact of the matter is that my belief the reported Rent of Primary Residence data and Owners Equivalent Rent (OER) data were substantially over-reporting rent price increases (relative to what real time market sources indicated such as the Zillow Observed Rent Index, the National Rent Report from Apartment List, the Redfin Rental Tracker, Costar, Realtor.com, etc.) has not mattered for some time. The number has felt sticky, and it has not allowed the disinflation to take hold, especially given modest increases in goods prices. I am just saying, “Now it will.” I do not believe the market will allow a re-acceleration of new leases, and with 40% of CPI being measured by this metric (35% of headline CPI), I believe we are going to see the data capture declining contribution to CPI from rents, helping to disinflate the total number.
Isn’t That a Good Thing?
If I believed it were all attached to a broader story of increased housing affordability, yes, it would be. Unfortunately, I don’t suspect we are talking about anything more than a “catch-down” effect in the data – a long overdue reporting lag that comes into the numbers, not exactly making anyone feel like their “cost of shelter” reality has gotten better. The broader subject of home prices (for sale) is not easily measured in the CPI (hence the awkward formulation of something called “Owners Equivalent Rent”). All we actually see, so far, is a collapse of home sale activity. The pump fake in December that indicated an increase was violently reversed in January. We continue to sit near 30-year lows in single-family residential sales volume. This cannot break without some downward price adjustment, something I eagerly embrace. We have just four months of supply at present, with inventory barely nudging in 2025 (up an underwhelming +3.4% versus a year ago).
This remains the reason the Fed and policymakers believe rates need to come down – to unfreeze would-be sellers into selling so a frozen market can thaw, and those with low mortgages can buy a new home without a massively higher rate.
So essentially, the total inflation data that I expect to show lower headline numbers as the year continues will do so with problematic internals.
Capex, Where Art Thou?
Data center construction is the only real capex anyone can find. If that were to change – more capex in other categories of the economy than just data center/AI – we’d have a much prettier picture. The big, beautiful bill did all it could to change it with serious tax incentives to do just that, and I hold out some optimism that it will still materialize. But the sentiment I see, the survey data I read, the monthly data coming in, the quarterly indications from public companies, and my own [anecdotal] conversations with business leaders all point to a business investment picture that has become one note – a data center monolith. I harken back to the post-GFC period, where the only business investment we saw for years was in fracking. The oil and gas sector exploded. It created real jobs. It was a good thing. But without any diversification in the economy and with limited geographic impact, it couldn’t pull total business investment to any kind of meaningful number for years, and both nominal and real GDP growth lingered at extremely subpar levels for years and years. Don’t get me wrong, we would have gone into a double-dip recession post-GFC if it were not for the fracking investment moment (roughly 2010-2014), and this data center investment is a real contributor to the economy. It. Just. Isn’t. Enough. One sector (really, one sub-sector within that sector) cannot do all the lifting.
And maybe it won’t. But it is right now.
But Wait, There’s More
What is most relevant to investors right now is not the thesis I have laid out above – that the reported inflation number will be ticking down in 2026 due to the impact of declining rent growth, even as other elements of the elevated price level remain sticky. Assuming all of that plays out exactly as I have said, one can easily see a political scenario where each side attempts to spin it to their advantage. And I already told you, I don’t give a whit about all of that.
But here is why I am writing this week’s Dividend Cafe … I believe the disinflation thesis may end up being more right than I have suggested, and for troublesome reasons.
That capex narrative is a big one. There has to be robust business investment – a realization of the supply-side policy enactment that has historically been very productive in driving strong economic activity – and it is not my base case that these things will materialize. Some of these headwinds, though, are increasingly becoming more of a base case.
First of all, the labor market. The data has been so mixed, so confusing, and so problematic for so long that I maintain the humility of agnosticism. What I do not see, though, is any scenario where “it looks really good!” The best case appears to be that the labor data is not meaningfully worsening – that the hiring freeze and firing freeze stay in place. I don’t want that – I want new job creation, and believe the economy needs it – but this “pause” is different than increased slack in the labor market (deflationary). I believe it is fair and honest to suggest that we have an “it gets worse” scenario as a possibility where unemployment picks up, and the lack of hirings is foreshadowing an increase in future firings. I do not, however, believe there is much reason to expect a scenario in which it gets meaningfully better. In other words, the “best case” scenario seems to be a “status quo” which suggests increased stagnation (more disinflationary than deflationary). The major job revisions for 2025 (and 2024 before that), the extremely soft private-sector indicators from ADP and Challenger Gray, and the Conference Board’s labor differential at its lowest level in four years all indicate a skew towards a worse-than-status-quo scenario ahead of us.
Additionally, one of the major arguments for improving economic activity in 2026 (from the administration, but also those who are making a plausible and serious economic argument) has been the expectation of significant tax refunds that are about to hit the checking accounts of many Americans (meaningfully above normal levels due to some of the provisions of the OBBBA). I agree that there will be greater-than-normal (one-time) tax refunds this year, mostly due to the disconnect between 2025 withholdings and actual tax rates. However, Dr. Lacy Hunt, one of my favorite living economists, has pointed out that the Personal Saving Rate (see the Chart of the Week below) being as low as it is (and even lower than reported once adjusted for the reality of spending increasing more than incomes) suggests that many tax refunds will be needed to replenish savings vs. enhanced spending.
It is entirely possible that the lower federal funds rate we have now than a year ago, and the lower federal funds rate we are likely to get later in the year, will enhance borrowing conditions for some consumers and businesses. But that is not a guarantee. Nominal lending levels did not move in 2025 despite easier financial conditions.
And then there is the big enchilada …
Tariffs are Less Damaging When They are Inflationary
I feel that this Dividend Cafe is aging well and will age even better as more time goes by. That tariffs can increase prices when importers can pass along the impact to consumers is rather obvious. That some importers cannot easily do so is also economically indisputable. What many have missed, though, and what was the focus of the aforementioned Dividend Cafe I wrote last year, is that when tariffs are not inflationary, they are worse. It simply means they put downward pressure on economic activity, employment, capital flows, and total trade. If they suppress demand, you may very well get lower inflation, but unfortunately, you won’t like it.
The follow-on effects of late years’ tariffs being disinflationary are not the kind of headline data the economy needs or wants, and certainly not in the political context the administration will want.
Now, did the Supreme Court just do the biggest favor to the administration for 2026 that anyone could have thought possible?
Conclusion
The media conversation, social media banter, and political spin around inflation and the economy are what they are. I find it generally very unsatisfying, and that is the most sanctified way I know of saying what I actually want to say.
But outside of spin, headlines, and banter, there are nuances in the way price data should be thought of that paint a complex picture. And we see disinflationary signs that are not desirable. Not for the political class. But not for the economy either.
Capex, come quickly. Productivity, business investment, and risk-taking – the supply-side of the economy. First principles are meant to live forever.
Chart of the Week
The Personal Saving Rate is as low as it has been since the financial crisis, indicating a need for many households to use their tax refunds to increase savings, not enhance spending.
Quote of the Week
“There are only two tragedies in life: one is not getting what one wants, and the other is getting it.”
~ Oscar Wilde
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I will have a very full weekend based on the massive Friday morning of news we have had. Monday’s Dividend Cafe is going to be a lot. And I am excited for it. Have a good weekend, and reach out with any questions, any time.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
