The strength of price increases in the November 2021 CPI (U.S. Consumer Price Index) report reinforces our expectations that the Federal Reserve will announce a faster pace of tapering at the December meeting, aiming for a March 2022 end to purchases, in our view. And as we discussed after the October CPI release (see blog post), we believe at its next meeting the Fed will also likely materially adjust higher its expected path of rates hikes as it focuses on returning policy to neutral over the next several years. While upside risks to inflation likely warrant a more hawkish stance, at the same time the central bank is mindful of the risk that inflation could moderate on its own, and that hiking the policy rate too early or too much could arrest the U.S. recovery.
Inflation risks inform Fed policy
While we continue to expect U.S. inflation to moderate next year, the risks of more persistent inflation have grown in recent months. Core inflation in the fourth quarter of 2021 will likely outpace the third quarter, but we don’t expect it will reach its peak pace from earlier this year. Because inflation expectations do appear to be adaptive, our view is that the longer inflation stays elevated, the greater the risk that consumers adjust their behaviors in a way that contributes to persistently elevated inflation.
We believe the Fed will want to manage this risk by shortening the time over which it winds down its purchases of U.S. Treasuries and agency mortgage-backed securities (MBS), aiming to end the program in March 2022, while also signaling a June rate hike is likely. We expect the Fed will start this communication process at its 14–15 December meeting by announcing a $30 billion reduction in asset purchases starting in January 2022, doubling the pace of the two months prior. The Fed also publishes updated economic and policy forecasts at the December meeting, and we expect the revised median rate path will imply two rate hikes in 2022, followed by three in 2023 and four in 2024. This would place the policy rate very close to Fed estimates of neutral by the end of 2024. While this is an aggressive change by historical standards (remember the “dot plot” was only introduced in 2012), we believe the risk is that the median path is revised even higher than we expect.
Key takeaways from November CPI: rents, goods, travel
U.S. core CPI gained 0.5% month-over-month (m/m) in November. Notably, rents and owners’ equivalent rents (OER) gained 0.4% for the third month in a row. This puts the measure on pace to accelerate back to 5.5% year-over-year (y/y) – well above its pre-pandemic trend. Low supply, pandemic-related demand for more space outside of urban areas, and low interest rates have all contributed to the fastest year-over-year acceleration in U.S. housing prices (18.5% y/y) in the history of the FHFA House Price Index, and it is spilling over into the rental markets.
Elsewhere, core goods prices were also firm amid continued strong demand for durable goods coupled with relatively inelastic supply. As expected, motor vehicle inflation was firm, with new and used vehicle prices gaining 1.1% m/m and 2.5% m/m, respectively. Vehicle damage from Hurricane Ida elevated used car prices in particular – a source of inflation that we expect to wane over the next few months – while logistical bottlenecks in the U.S. and production disruptions across the global supply chain have reduced inventories across various retail goods categories and raised prices.
Retail goods price inflation is now running around 4.5% y/y, in contrast to the deflationary trends that existed pre-pandemic, as an earlier start to the holiday shopping period and low retail inventories contributed to another strong month for goods prices. Retailers have been successful in enticing customers to do their holiday shopping early or risk facing empty shelves, and this has been met with less discounting relative to typical holiday shopping periods. Indeed, apparel (+1.3% m/m), household supplies (+0.7% m/m), and recreation goods (+0.3% m/m) all experienced strong price gains.
Finally, the decline (through November) in daily new cases of COVID-19 in the U.S. contributed to recovering demand and rising prices in the travel services categories. Airfares rebounded (+4.7% m/m) after prices fell for four straight months, though airfares are still down 20% versus pre-COVID levels, as corporate travel remains depressed. By contrast, hotel prices were strong for the second straight month (+3.2% m/m); prices have exceeded pre-COVID levels as many people travel by car and compete for lower supply given some hotels haven’t reopened. The omicron variant appears to be the key risk to a further recovery in U.S. travel services prices over the next quarter. Indeed, pandemic-related risks are likely to remain a key uncertainty and source of disruption in many areas of the economy.
Visit PIMCO’s inflation page for further insights into the inflation outlook and investment implications.
Tiffany Wilding is an economist focused on North America and a regular contributor to the PIMCO Blog.