These global inflationary pressures have been further compounded by the domestic effects of Hurricane Ida. The storm disrupted oil production in the Gulf of Mexico, but also damaged a large number of motor vehicles. The subsequent replacement demand, amid already low auto inventories, already appears to be affecting wholesale prices for used cars, and we expect this to further boost the prices of consumer used vehicles in the months ahead.
These factors raise the prospect for another bout of 5% or more annualized U.S. inflation in the fourth quarter. And although we continue to believe that these factors will be temporary, and inflation will moderate in 2022, they are likely to raise the calculated year-over-year rates above 3% into the third quarter of next year.
Next several months will be challenging for the Fed
While we still expect U.S. inflation to return to the Fed’s target by the end of 2022, additional months of above-target inflation raise the risk that inflation expectations accelerate beyond levels consistent with the 2% target – something the Fed will want to avoid. As a result, effectively communicating the outlook for monetary policy over the next few quarters is likely to be challenging for the Fed for this and several other reasons.
First, while Fed officials likely want to manage the risk of an unwanted “jump” to higher inflation expectations, they will have to weigh this risk against the most likely outcome that inflation dissipates by itself. Since monetary policy works through long and variable lags, it’s possible that inflation could have already dissipated by the time the economy starts to adjust to early rate hikes.
Second, several pending leadership transitions raise the prospect of shifting policy views of the FOMC’s leadership, which may contribute to greater uncertainty and market volatility. And while we expect Chair Powell to be renominated, concerns raised by progressive Democrats make that outcome more uncertain.
Lastly, the Bank of Canada and the Bank of England are communicating their plans to raise rates ahead of the Fed. While earlier liftoff from other smaller developed market central banks should not directly influence Fed policy, officials will monitor the impact of policy adjustments abroad on U.S. rates and the dollar in the context of broader financial conditions, which do affect the U.S. economy.
PIMCO’s Fed outlook still below market pricing, but with upside risk
We continue to forecast the Fed’s first post-pandemic rate hike in the first quarter of 2023, but we also see the risks tilted toward earlier action. As for the subsequent path for rate hikes, across various scenarios our average forecast runs about 1 to 1.5 hikes below what markets are pricing by the end of 2023. As we discuss in our latest Secular Outlook, “Age of Transformation,” financial market sensitivity to higher rates may again prevent central banks from moving meaningfully away from their zero lower bound.
