Investors should see a rise in past inflation
The writer is a North American economist at Pimco
Over the next few months, investors should expect to see an adjustment in consumer prices in the United States, which will look a lot like a lasting change in inflation.
The March US Consumer Price Index report confirmed the first step in this expected adjustment, with core inflation rising 0.3% per month. The readings for April and May could be similar. Headline inflation is expected to accelerate to 3.5% year-on-year by May – the fastest pace in a decade.
Rising commodity prices, trade bottlenecks and projections for the fastest rate of growth in 40 years have contributed to concerns about overheating, which could become more acute as activity picks up. economic alongside better public health prospects.
Financial markets appear to be weighing the possibility that the US Federal Reserve will be more aggressive in raising interest rates than it is currently telegraphing.
Still, as the economy normalizes further in the second half of 2021, we expect a slowdown in sequential growth in real economic activity and prices, which will slow the pace of inflation year on year. the other. Price pressures are expected to stabilize as vaccination rates rise, shipping and supply routes clear, and durable goods purchases ease.
We expect core CPI inflation to end the year just below 2 percent. While that gauge is expected to accelerate to 2.2% in 2022, the differences in the construction of the index mean that the Fed’s preferred core personal consumption expenditure price measure will be lagging behind. That may be all the markets need to moderate expectations of a tougher Fed policy.
The Fed’s policy committee is forecasting core PCE inflation of 2.2% at the end of this year, 0.5 percentage points above our forecast. Based on comments from members of the policy-making committee, it appears the Fed expects a somewhat larger time lag between when the supply comes back online after the pandemic disruptions and when the supply comes back online after the pandemic disruptions. demand is accelerating.
While a perfect factor storm has contributed to global factory and shipping bottlenecks, the brunt of price increases resulting from these issues has likely already occurred, and we are skeptical that the situation s ‘will worsen enough to result in core inflation 0.5 percentage points higher than we now expect. over the next few months.
With container ship freight rates already hitting high levels for several years and with retailers passing the extra costs on to consumers, we wonder how much further inflation to expect. Retail inflation is already flat after falling 1.5% year-on-year in May 2020. Our forecast calls for this pace to climb to 2% over the next few months – the fastest in more than 10 years.
Yet we do not expect persistent inflation. Consumers have replaced services with durable goods in 2020. In 2021, we expect the demand for durable goods to likely decline somewhat as more people get vaccinated and start consuming services again. This could reduce the ability of retailers of these products to pass on higher costs. In turn, this could offset inflationary pressures in other categories of services, such as airline tickets and accommodation.
These categories are expected to experience a strong recovery as travel picks up. But hotels and airline tickets each account for less than 1% of the CPI, which is not enough to guide the trajectory of inflation in the United States.
In contrast, housing represents a third of the CPI basket. Home prices in the United States have risen 11 percent over the past year, due to demand for more space away from major urban centers. However, US statistical agencies consider buying a home as an investment and instead use rental rates to measure changes in the cost of housing, even for owner-occupied homes.
As a result, rent and owner’s equivalent rent are more sensitive to both labor market trends and the cost of owning a home compared to renting. According to the Bureau of Labor Statistics, rent inflation fell to 2.0 percent year on year from March, from 3.3 percent before the pandemic. The recovery in the labor market should support rental demand, as should rising interest rates make home ownership less affordable for some. But rent increases will not be as strong as house price inflation.
Inflation concerns have helped propel US bond yields higher over the past six months. In the short term, each new economic data point may seem more indicative of accelerating growth.
We believe that the recovery in demand should help prices to normalize this year. But while government stimulus is likely to narrow the gap between real and potential GDP this year, we don’t expect a large and persistent overshoot of this change to contribute to soaring inflation.
Allison Boxer from Pimco contributed to this article