Economic and Market Commentary

Inflation Uncertainty: What’s Coming?

Dr. Ben Bernanke, senior advisor to PIMCO, and Joachim Fels, global economic advisor, discuss what’s a concern – and what isn’t – with regard to rising short-term inflation.

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Text on screen: PIMCO

Text on screen: PIMCO provides services to qualified institutions, financial intermediaries and institutional investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized

Text on screen: Joachim Fels, Global Economic Advisor

Joachim Fels: We are looking for a spike, but not a spiral in inflation. In the next few months, we are likely to see a pretty strong surge in inflation rates and year over year inflation.

Text on screen: TITLE – Short-term inflation head fake; BULLETS – Base effects, commodity price recovery, supply chain disruptions and low inventory, rebounds in COVID-sensititve sectors

One reason for that is base effects. We had pretty dramatic price declines in the affected sectors last March and April when the pandemic hit. And these price declines were rolled out of the 12 month window. So these are the base effects. Secondly, we've had quite a run-up in commodity prices, particularly in energy prices. And this will obviously affect headline inflation; has already started to affect headline inflation. And we'll likely see more of this in the next couple of months.

Thirdly, there are some supply bottlenecks in important sectors of the economy that will have some impact on prices also downstream. And then finally, in those sectors that will be reopening, you're likely to see price adjustments upwards as activity ramps up and demand ramps up in those sectors. So think airfares, think room rates and hotels, et cetera. So all of this explains why inflation rates over the next several months are likely to rise very significantly.

Text on screen: TITLE – A bumpy near-term ptah for U.S. CPI inflation

For example, here in the US, we see headline CPI inflation reaching around 3.5%. So this would be roughly double the current rate, 1.7%. And we think that peak will probably be reached around May of this year.

Text on screen: Tina Adatia, Fixed Income Strategist

Tina Adatia: Thank you, Joachim, and that inflation uncertainty is something that we want to talk about in a little bit more detail. So thank you Joachim for sharing PIMCO's view on this. And at this point, I'd like to turn to you, Dr. Bernanke. Is there a risk that we'll end up with unexpectedly high inflation, and sort of in other words, kind of what's the risks that policy is just too easy then?

Text on screen: Dr. Ben Bernanke, Chair of PIMCO Global Advisor Board, Former Federal Reserve Chairman

Ben Bernanke: Now I do think, as Joachim said, that there will be some near term inflation in 2021 for the reasons he'd mentioned, including base effects, commodity spending, opening up, et cetera. And I think it will create some anxiety at times in markets. However, my sense is my best guess is that inflation will remain well within the Fed's goals. Remember inflation is roughly 1.5%. the Fed would like to see it at least for a time as high as 2.5%. So it would like to see higher inflation. It's not resisting that. And I think there are a number of reasons why we would not expect to see inflation reach levels that are really uncomfortable for the Fed. And let me just mention a few.

First, I think the amount of slack in the economy is probably greater than conventional estimates, like the 3% CBO estimate, really suggest you've got participation rates. That is the number of people who are actually working or looking for work, which are similar today to what they were immediately at the beginning of the great recession or the beginning of the recovery from the great recession. So that's suggested, but there's a bigger gap there than maybe some think. Secondly, the monetary and fiscal stimulus we're getting is not expected to continue year after year. The big $1.9 trillion program will be mostly exhausted over the next year.

By next year, at some point fiscal policy will be taking a step back. Monetary policy will probably be taking a step back. So we don't expect a long-term persistent overshoot of the economy's potential that would create sustained inflationary pressures. You mentioned the infrastructure, by the way, just to emphasize the headline number is very big, like $2 trillion, but this is something that is intended to happen over 10 years, not in next to the next year and be partly paid for by taxes. The third point is I think that while there's a lot of money out there, including not only the fiscal stimulus, but the accumulated savings, a lot of it will be saved. People will be saving it or paying down debts, paying back their rent, states and local governments will be replenishing their rainy day funds. Higher income, middle-income people who are receiving those $1,400 checks will put a lot of it into the bank. So I would not expect to see all of that money being immediately spent, particularly since it's going to take some time before people get used to going out and spending and shopping and working in the normal way as the economy opens up.

I should mention the fact that of course the US economy is growing strongly, but many other parts of the world are not growing as strongly for various reasons. So some of the demand that were seeing in the US will spill over into a trade deficit, will be supportive of our trading partners, rather than creating demand at home.

And then finally, and very importantly is the Fed. I think that inflation expectations are not perfectly anchored. Inflation may adjust some, but overall the Fed does have a lot of credibility and it's laid out pretty clearly how it's going to respond to higher inflation. And so overall, while I do think that inflation will pick up some I just want to remind everybody that that's what the Fed is aiming for, and that by achieving a modestly higher inflation rate, we can both avoid the risks of a Japan trap type situation and perhaps get a hotter labor market that will give more people opportunities for work and for careers.

Text on screen: For more insights and information visit global.pimco.co

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Please note that the following contains the opinions of the manager as of the date noted and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.

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