Before anyone had time to fully explain June's inflation numbers, the growls had already begun on trading desks and research shops:
Maybe in two weeks the Fed will raise interest rates by a full percentage point — the most at a single meeting in its modern history.
This increasingly likely scenario shows the jam the Fed has gotten itself into, with Fed officials seeking to express to the country a whatever-it-takes attitude. Neil Irwin and Courtenay Brown say that’s put them in a corner.
It’s a precarious situation where high inflation reports demand a mounting series of interest rate hikes and other policy moves that end with reduced consumer and business spending and a cratering economy.
Just last month, a high May inflation reading drove Fed leaders to make a last-minute shift to raise interest rates by 75 basis points, not the 50-point increase they had been signaling.
Well, here we go again. Wednesday's BLS report showed a 9.1% rise in the Consumer Price Index over the last year — and perhaps more significantly, the uptick of monthly core inflation to 0.7% in June.
And yesterday’s Producer Price Index, which essentially reflects wholesale prices charged to retailers, was even higher – at 11.3%.
It was a "major league disappointment," as Fed governor Christopher Waller said in a speech afterwards. The stock markets agreed.
The reports set off alarm bells throughout the financial world that recent history would repeat itself and, by day's end, the CME futures markets would almost fully price in a one-percentage-point rate hike at the end of the month.
Americans expect inflation to drop precipitously over the next three years, according to the New York Fed.
And Neil Irwin says “that's great news for anyone who doesn't want current prices to become the new normal.”
The NY Fed’s July Survey of Consumer Expectations, released today, shows marked drops in how households expect inflation to be across a variety of time horizons.
History shows that the higher we expect inflation to be, the more likely it becomes a self-fulfilling prophecy as businesses feel more comfortable raising prices and workers demand steeper wages.
In that sense, Irwin says falling inflation expectations “are a welcome sign that the high inflation of the last year is not causing a long-lasting shift in Americans' psychology around money.”
But inflation expectations in the July survey remain far above the levels that we saw in the years before the pandemic and are above the 2% inflation rate the Fed target.
In fact, consumers expect inflation to be 6.2% over the next year. That’s down from 6.8% in June and is the steepest one-month drop since the survey began nine years ago (CPI rose an annual 9.1% in June).
The potential good news lies in expectations over the next three years having fallen to 3.2% from 3.6%, and 5-year expectations to 2.3% from 2.8%
Irwin reports that the drop was most evident among survey respondents making less than $50,000.
He surmises that’s a possible reflection of those consumers, who were most affected by soaring oil and gasoline prices, seeing relief at gas pumps last month.
Fed chair Jerome Powell mentioned the NY Fed's results as a reason to continue aggressive rate increases at the Federal Open Market Committee’s June policy meeting.
Thus, Irwin believes the falling expectations “will likely give comfort to the central bank.”