Over the next three to five years, PIMCO expects the global economy will continue along a New Neutral path in which major economies tend to drift along at modest growth rates. At our annual Secular Forum this year, our global investment professionals rigorously debated the longer-term, or secular, outlook for the global economy and markets, and the broad conclusions we reached are detailed in “The New Neutral Revisited.” Mihir Worah, Chief Investment Officer Real Return and Asset Allocation, drills down on the firm’s views on the future of inflation and the role of commodities in inflation and growth estimates.
Q: What is PIMCO’s outlook for inflation over the secular horizon, and what are the risks to that outlook?
Mihir Worah: The inflation outlook is an important component of our secular New Neutral view, which factors in major central banks conducting reflationary monetary policies to support economic growth. Our base case view is that global inflation will accelerate gradually from the current very low levels toward central bank targets of around 2% over the next few years, with the US economy leading the way.
While there is always two-way risk around the base case, we think inflation is more likely to surprise to the upside, overshooting central bank targets. This is a very real possibility over the secular horizon in the US, less so in Europe or Japan. Note that the Federal Reserve, with its massive balance sheet and its extraordinary monetary policies, still has not generated sufficient inflation. But as the economy has healed and the amount of slack has reduced, we might see the old definition of inflation reappear: too much money chasing too few goods. Frankly, many central banks would probably welcome a modest overshoot.
We don’t think the downside risk—deflation—is likely in the next several years. Back when the economy was just coming out of the global financial crisis, we were constantly flirting with the possibility of deflation. A combination of lack of global aggregate demand as well as the correction in commodity prices (too much supply) contributed to this. Unprecedented policy actions by major central banks, including the Fed, the European Central Bank and the Bank of Japan, have largely contributed to this diminished likelihood of deflation. While we are calling for a modest overshoot of the Fed’s 2% target, not runaway inflation, I would stress that PIMCO’s view is counter to the prevailing view of many economists and market participants who still factor in significant deflation risk.
Q: What will be the main drivers of global inflation?
Worah: Over the secular horizon, the drivers of inflation will be more balanced, with both services and goods contributing to higher prices. Goods inflation saw major swings over the past several years, dominating overall inflation during the commodity supercycle and then shifting into deflationary mode with the drop in commodity prices. Now that we see the price correction is largely over, goods deflation should moderate, though the strength of the US dollar could still present some drag.
Services inflation has been generally steady all that time, with a one-time downward shock in medical inflation due to the Affordable Care Act. Over the secular horizon, we should see services inflation supported by growing economies, higher wages and higher rents. The key difference over the next five years compared with the past is that services and goods inflation will both be contributing to inflation, with much reduced volatility from the goods or commodity sector.
Read more from this interview in PIMCO’s Secular Outlook Series.
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