The Friday before the Federal Reserve’s interest-rate decision will be most remembered for the surprise acceleration in consumer prices, which took inflation to a fresh 40-year high.
But there was another piece of data released that day that seemed to have weighed at least as much on the minds of Federal Reserve policymakers — the inflation expectations data from the University of Michigan’s consumer sentiment report. The expectation of inflation five years from now rose to 3.3% in June from 3% in May, the first increase since January.
“We got the CPI data and also some data on inflation expectations late last week, and we thought for a while, and we thought this is the appropriate thing to do,” Powell said of the decision to hike by 75 basis points instead of the 50-point hike he previously suggested.
“The preliminary University of Michigan reading — it’s a preliminary reading, it might be revised — nonetheless, it was quite eye-catching, and we noticed that,” he said. Powell also referenced a rise in an internal Fed measure, called the index of common inflation expectations, which is essentially is a basket of various inflation expectations readings.
Goldman Sachs has created a monthly version of the Fed’s indicator, as the central bank only updates its numbers on a quarterly basis. According to the bank, the index is at the highest level since 1999. And the Fed’s calculations of those expectations have recently been changed to put greater weight on household expectations.
Economists note the focus on expectations creates a bit of an issue for Powell. Consumers may well be the engine of U.S. economic growth — and even global growth — but historically they have not been particularly good predictors of future inflation. More or less, inflation expectations at the consumer level move in line with gasoline prices.
Right now, gasoline prices are moving in the same direction as other costs. But there could very well be a scenario where so-called core prices start easing, but gasoline prices do not.
“So unless consumers fade further increases at the pump, inflation expectations at a minimum will remain elevated. This easily creates a scenario where we could see another 75bp increase,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets.
“As it relates to the off-ramp idea, if we get to the point where core is slowing nicely but food and gas are keeping expectations elevated, per the Fed’s inability to impact those two things (which Powell acknowledged), expectations should necessarily matter less than Powell seemed to suggest,” he added.
U.S. stock futures
were pointing sharply lower on Thursday, after gains made in the U.S. stock market
on Wednesday. The yield on the 10-year Treasury
rose to 3.44%.