MNI: Inflation Expectations Already Unmoored -Ex-Fed Officials

Consumers and businesses are already starting to build in higher expectations of inflation over longer horizons despite assurances from top Federal Reserve officials that long-run expectations are still well contained, former Fed officials and staffers told MNI.

The Fed’s emphasis on expectations as perceived by market participants is too narrow and is missing a broad underlying shift in the economy, they said.

“We are in a situation where consumption could be affected, so what you really want is consumer expectations. I don’t care about the market’s expectations," Raphael Schoenle, former deputy director of the Cleveland Fed’s Center for Inflation Research, said in an interview.

“Inflation expectations are quite behavioral -- I think it’s wrong to assume they are coming down very quickly.”

MARKET-BASED MEASURES

Fed officials have specifically emphasized the five-year five-year forward measure is still in line with historical norms, but historical evidence for its usefulness as a guide to future prices is unconvincing, said Jeffrey Lacker, former president of the Richmond Fed.

“What matters for people’s price setting now, what matters for what wage gains they ask for, that is current inflation and that is high and expectations for inflation over the next year is out,” said Lacker in an interview with MNI’s FedSpeak podcast. (See: MNI: INTERVIEW: Fed May Need To Raise Rates To 5% - Lacker)

“In past episodes of inflation surges, the bond market has been relatively slow to realize how persistent the inflation shock is. I don’t put a lot of hope" in those measures, he said. “When we get five years out then we’ll see where inflation expectations for that year are. It could be where the forward curve says it is, but there’s a lot of variance around that.”

LONGER-RUN EXPECTATIONS

The University of Michigan’s long-term inflation expectations measure, which gauges views five years out, jumped to 3.3% in early June from 3% in May. Aside from a single 3.4% print in 2008, this is the highest reading since the mid-1990s.

“The increase in long-term inflation expectations is very concerning,” said Joanne Hsu, head of UMich’s consumer survey and a former Fed board economist. “Consumers aren’t 100% convinced that policy will be able to get inflation under control."

New York Fed survey data out Monday confirmed inflation expectations are rising, with consumers seeing inflation at 6.6% one-year out, a record for that index.

Coupled with last week’s surprisingly strong 8.6% rise in the May CPI, the move has prompted speculation, fueled by a Wall Street Journal article, that the Fed will hike interest rates by 75 basis points this week rather than the 50 bps previously expected.

“They want to make sure that inflation expectations don’t become unanchored,” said ex-Fed governor Randall Kroszner in an interview last week. “They have the opportunity now relatively quickly to make sure they don’t.”

The window may be increasingly narrow, however, the longer these price pressures stick around.

"Households tend to put more weight on price increases rather than cuts when forming inflation expectations, which means that even if the Fed was successful in curbing inflation in the short run, it would still take quite some time for inflation expectations to come down," said Michael Weber, an outside adviser to the Cleveland Fed.