US Elevated Inflation Likely To Moderate, Expect "Quantitative Tightening" – PIMCO

Editorial Staff

28 January 2022

The elevated US inflation rate will moderate as the impact of labor and product market disruptions caused by the pandemic and associated government controls ease up, according to one of the world’s largest fixed income investment houses.

A March rate hike is likely to trigger a sequence of quarterly rate hikes from the US Federal Reserve, Tiffany Wilding and Allison Boxer, economists at PIMCO, said in a note yesterday.

Jerome Powell, chairman of the central bank, this week said the Fed was ready to raise rates at its March 15-16 meeting and could continue to lift them faster than it did during the past decade.

A run of high inflation figures have rattled policymakers. While the supply chain disruptions, including hits to energy markets, are widely blamed, the large central bank quantitative easing programs of the Fed and others are a factor. In 2020, for example, a quarter of all the dollars circulating had been printed that year. Inflation has been strong: The Consumer Price Index for All Urban Consumers rose by 0.5 per cent in December on a seasonally adjusted basis after rising 0.8 per cent in November. Over the last 12 months, the all index items increased 7.0 per cent.

Such figures, and the prospect of rate hikes, are forcing wealth managers to re-appraise the secular themes that have dominated thinking for more than a decade. For example, since before the 2008 financial crash, bond yields have been low, or often negative, in real terms. Yields on conventional listed equities have been squeezed, encouraging a big inflow to private markets such as private equity and venture capital.

PIMCO struck a cautiously optimistic note: “Although aggregate wage pressures have accelerated as labor markets tighten, the balance of evidence still suggests that the currently elevated level of headline inflation will moderate as pandemic-related frictions in labor and product markets moderate over time.”

“With inflation still well above the US Federal Reserve’s target and the unemployment rate now below estimates for the long-run maximum level, the Fed reiterated recent guidance following its January meeting: Officials expect to hike the policy rate in March, kicking off a series of four rate hikes in 2022,” the economists said. “Although the Fed’s near-term rate trajectory indicates a sooner and more rapid rise in response to inflationary risks, we haven’t changed our expectation that a still-low neutral rate, larger central bank balance sheet, and generally higher economy-wide debt levels will keep the terminal level of this rate hiking cycle at or even below that achieved in 2018 ,” they continued.

They noted that the Fed has flagged an earlier start to winding down the central bank’s balance sheet – aka quantitative tightening or QT – by releasing a list of balance sheet policy principles, which informed wealth managers about the Fed’s plan for a significant reduction in assets held.

PIMCO’s economist said they expect the Fed to begin QT around mid-year , when the Fed funds rate is expected to be above 0.5 per cent.

They noted that Fed chair Powell has stopped short of hinting that a 50 basis point rate hike is likely in March .

“While Chair Powell confirmed that the committee believes it has achieved the labor market and inflation benchmarks needed to begin the rate hiking cycle, inflation is still expected to moderate over the coming quarters, likely reducing the need for an abrupt adjustment at the March meeting,” they added.