MNI INTERVIEW: Rising Price Expectations Could Prompt Fed Hike
MNI (WASHINGTON) - Rising U.S. consumer inflation and inflation expectations at the start of the year warrant concern and if sustained could prompt the Federal Reserve to hike interest rates by mid-2025, Michael Weber, a University of Chicago economist and Cleveland Fed and National Bureau of Economic Research affiliate, told MNI.
Even before President Trump follows through on tariff threats, consumers are pulling forward spending and firms raising prices in anticipation of higher production costs, Weber said in an interview. The acceleration in CPI in January supports that narrative, he argued.
"I wouldn’t be surprised if the Fed sees that price pressures keep rising, they might say that’s enough, let's tighten by 25 basis points two meetings in a row in the summer, and by the end of the year start cutting rates again," he said. "I would assign a 30% probability to that scenario."
PCE inflation is expected to accelerate to 3.0% in the first quarter from 2.5% in the final three months of 2024, according to a Cleveland Fed Nowcast. More worrisome is the surge in price expectations since the election. The University of Michigan’s February survey showed median consumer inflation expectations over the next year had risen to 4.3% and over the next five to 10 years to 3.5%, a 30-year high.
STILL ANCHORED?
Weber's own large opinion survey, fielded just weeks before Trump took office, also found the anticipation of tariffs was likely already affecting the decisions of households and firms.
"In times of higher uncertainty, firms pre-emptively start increasing prices. If they knew for sure tariffs are coming, they would increase by even more," he said. "If consumers anticipate higher prices anyway, firms become less concerned that if they raise prices, consumers will substitute to their competitors. So firms effectively have more pricing power."
Higher inflation expectations also trigger consumers to bargain for better pay or switch jobs, dynamics well remembered from the Covid-era price surge.
Most Fed officials say they expect disinflation to continue along a bumpy road, downplaying the surprisingly strong January report but also predicating further rate cuts on actual inflation progress. Investors have maintained bets for two or three cuts this year. (See MNI: Fed In Holding Pattern As Inflation To Stay High-Ex-Staff)
Weber questions whether inflation expectations are still anchored at 2%, as central bankers say, noting that the mean of Michigan survey responses on longer run inflation has nearly doubled relative to pre-pandemic years, to above 6%.
"The gap between median and mean expectations is widening and driven by a heavy right tail of people expecting very high inflation. That's a concern," he said.
ECONOMIC SLOWDOWN
A worse scenario for the Fed would be inflation stays high but growth falters, a non-negligible risk as tariffs are both inflationary and activity stunting, Weber said.
At the moment firms are passing on higher costs to consumers who remain able and willing to pay, but spending has been increasingly concentrated in the top part of the wealth distribution, buoyed by skyrocketing asset prices.
High uncertainty will at some point take a toll on historically elevated valuations, Weber said, adding some analysts have already marked the past week as the beginning of a prolonged correction.
"My biggest concern is once stocks see a correction of 10% or more, this will be a big drag on consumption," he said.
'"For now the Fed is in a comfortable spot to watch data come in, and hold, ease or tighten as required."