Our current bout of inflation was initially attributed to supply chain shocks, the war in Ukraine, and other “transitory” issues. These problems seem to be abating and the reported rate of inflation has now declined for ten consecutive months. However, the Federal Reserve continues to be concerned about another potential source of pressure on prices which is inflation expectations. Simply stated, if consumers and businesses expect rising prices, they purchase items peremptorily which actually makes rising prices a reality. If left unchecked, this pattern evolves into an inflationary spiral.
The University of Michigan does a monthly survey in which they ask respondents for their one and five-to-ten-year inflation expectations. The May survey showed an expectation of 4.5% over one year and 3.2% annually for the next five-to-ten years. Importantly, the 3.2% longer-term forecast represents a twelve-year high. It is also possible to gauge investors’ inflation expectations by comparing the yield on the nominal U.S. Treasury Bonds with that of the Inflation-Protected Bonds or TIPS. Using this methodology, the bond market’s current forecast of ten-year inflation is 2.19% which is in line with the FED’s long-term target. So, are consumers or investors right? The consensus is that the FED will “pause” interest rate increases for the moment. However, it will be very important in the coming months to monitor consumer inflation expectations in order to determine when the Fed will feel comfortable actually reducing rates.