Fed sees inflation expectations slip

The University of Michigan’s May consumer survey delivered a number the Federal Reserve watches closely: households raised their longer-run inflation expectations even as the latest price shock was still centered on energy. The survey, released May 23, said one-year inflation expectations edged up to 4.8% from 4.7% in April, while five-year expectations jumped to 3.9% from 3.5%. The survey’s accompanying commentary said consumers appeared worried inflation would “increase and proliferate beyond fuel prices, even in the long run.” ### Why does a move in five-year expectations matter more than another jump in gas prices? The Federal Reserve has long treated inflation expectations as a test of credibility. Adriana Kugler, a Fed governor, said in an April 2 speech that expectations have played “a crucial role” in inflation since 2022, and cited former Chair Ben Bernanke’s definition of anchored expectations as ones that are “relatively insensitive to incoming data.” (sca.isr.umich.edu) A rise in gasoline prices can lift near-term expectations without necessarily changing the central bank’s broader outlook. A rise in five-year expectations is more difficult because it suggests households may no longer assume inflation will return to the Fed’s 2% objective on its own. The University of Michigan survey’s language pointed directly to that risk by saying concern was extending “even in the long run.” (federalreserve.gov) ### How unusual was the May reading? The University of Michigan’s five-year expectation measure rose to 3.9% in May from 3.5% in April, according to data reproduced by Trading Economics from the Michigan series. That is well above the measure’s 2019 low of 2.2% and above its long-run average of 3.21%, though still far below the peaks reached in 1980. (sca.isr.umich.edu) The broader sentiment backdrop also deteriorated. Michigan said final May sentiment fell as consumers reacted to higher gasoline prices and Middle East tensions, with independents and Republicans both posting declines. The survey said Democrats’ sentiment was little changed from April. ### Didn’t another Fed survey show longer-run expectations staying stable? (tradingeconomics.com) The New York Fed’s April Survey of Consumer Expectations showed a different picture. The New York Fed said median inflation expectations rose to 3.6% at the one-year horizon in April, but were unchanged at 3.1% at three years and 3.0% at five years. That gap matters because the two surveys measure different samples and ask questions differently. (sca.isr.umich.edu) Reuters, in a May 7 report on the New York Fed survey, noted that the relative calm in that survey contrasted with “notable deterioration” in University of Michigan sentiment data. ### What does this change for the Fed? (newyorkfed.org) John Williams, president of the New York Fed, said on April 16 that he pays “close attention” to inflation expectations because well-anchored expectations are “invaluable” to maintaining price stability during shocks and uncertainty. That makes the Michigan result notable even before it shows up elsewhere. The Cleveland Fed’s inflation-expectations series, which combines market prices and surveys, is another gauge officials can use to check whether household worries are feeding into longer-dated pricing. (money.usnews.com) The San Francisco Fed said in a March letter that the five-to-ten-year forward breakeven inflation rate has generally stayed in a range broadly consistent with the Fed’s longer-run target once differences between CPI and PCE are considered. (newyorkfed.org) ### What should investors and readers watch next? The next test is whether May’s Michigan readings are echoed in other measures rather than fading with fuel prices. The New York Fed’s next monthly Survey of Consumer Expectations will show whether its three-year and five-year medians move off April’s 3.1% and 3.0% readings. Federal Reserve officials will also have the Cleveland Fed’s updated expectations estimates and incoming inflation data before their next policy decisions. (clevelandfed.org) If those measures do not confirm Michigan’s jump, the May survey may look like a shock response tied to energy prices; if they do, officials will have to address a broader rise in long-run inflation expectations. (newyorkfed.org)