SF Fed's Inflation Shock Index Suggests Sticky Prices Ahead

Historical tests align with known episodes. The ISMI climbed sharply during the Great Inflation of the late 1970s and early 1980s, then turned negative and stayed negative through the disinflation of the 1990s. It bounced around zero during the early 2000s when PCE inflation ran near 2%, then turned negative with the Great Recession and stayed negative through most of the 2010s. The pandemic era saw a deep plunge at the onset, then a rapid surge through 2021 and 2022 as inflation hit a 40-year high in June 2022. After that peak, the index declined faster than headline PCE inflation and eventually went negative, signaling broad disinflationary pressure even before the Fed’s target was reached.

The ISMI also responds to macroeconomic shocks in ways consistent with theory. A monetary policy tightening shock, identified by Romer and Romer, sends the index down for an extended period, reflecting sustained demand restraint. A negative oil-supply news shock, identified by Känzig, pushes the ISMI up only temporarily, aligning with the view that supply-driven price spikes tend to fade.

For markets, the current near-zero ISMI reading has a direct read-through. If inflation persists near current levels, the Federal Reserve is unlikely to cut rates aggressively. That keeps pressure on short-term yields and supports the dollar versus currencies with looser monetary commitments. Long-duration bonds face a higher term premium. For market analysis, the persistence signal argues against positioning for a sharp disinflation trade in the near term. Gold and cryptocurrencies, which rallied on expectations of rate cuts, may pause if the Fed holds steady. The oil market could see more sensitivity to demand-side inflation data rather than supply headlines.

The index is updated monthly on the San Francisco Fed’s data page. The next reading will offer the first test of whether the near-zero reading holds into summer. If the ISMI turns positive, it would signal renewed upward pressure; if it goes negative, disinflation may accelerate. For now, the signal is simply: same inflation, same policy.