MNI INTERVIEW: Inflation Expectations Surge, Troubling For Fed

Federal Reserve officials find themselves in an increasingly tenuous position as a surge in inflation expectations to multi-decade highs coincides with worries about the labor market now at their worst since the Global Financial Crisis, Joanne Hsu, the head of the University of Michigan's Survey of Consumers told MNI.

"It's an open question" whether long term inflation expectations are anchored, she said in an interview. "We can't really write off that inflation expectations may stick where they are right now. Whether you want to call that anchored or unanchored - if they were to stick where they are right now - it's still higher than what the Fed wants to see." 

The preliminary Michigan April survey showed year-ahead inflation expectations increased from 5.0% last month to 6.7%, the highest reading since 1981. Long-run inflation expectations increased from 4.1% to 4.4% in April, the highest since 1991. Michigan is not an outlier amongst inflation expectations measures, she said, adding that while the New York Fed's headline survey numbers remain stable, the underlying picture is mixed.

At the same time, consumer sentiment is deteriorating sharply, leaving Fed policymakers in an unenviable position. 

STAGFLATION SIGNS

"We're seeing signs of stagflation. It's not only that consumers are expecting unemployment to go up. They are expecting to be personally affected by this deterioration," she said. "This is extremely problematic and at the same time they're also expecting higher inflation. I'm seeing warning signs on both elements of the dual mandate and I don't envy those policymakers."

The University of Michigan’s Consumer Sentiment Indicator pulled back 10.9% to 50.8 in early April, below the 53.5 consensus forecast and the third lowest reading on record. The current conditions index plunged 11.4% to 56.5 and expectations fell 10.3% to 47.2. Americans' expectations for the next year are now the worst in 45 years and down 40% in five months.

Top officials across the Fed system this week have said it is critical that inflation expectations do not continue to rise and that long-run expectations remain anchored. Officials have cited the University of Michigan's Survey of Consumers data as an outlier amidst other consumer inflation expectations measures that are more benign. 

"In the short run, inflation expectations are being driven by by developments with tariff policy," Hsu said, adding that the survey closed on Tuesday before President Donald Trump's tariff policy changes on Wednesday. "The final read for April will be very important. I don't think that the pause on the reciprocal tariffs are likely to improve consumer views too much." (See: MNI INTERVIEW: Fed To Closely Gauge Inflation Views - Schoenle)

"A rollback [on tariffs] isn't necessarily going to calm consumers down if they think that an escalation can happen at any time," said Hsu, a former principal economist at the Fed board's division of research and statistics. 

SPENDING RED FLAG 

The share of consumers expecting unemployment to rise in the year ahead increased for the fifth consecutive month and the highest since 2009.

"We have these inflation expectations for the future that might lead consumers to front load their purchases and boost their spending right now, but at the same time they feel so bad about the future of the economy, and particularly with labor markets," she said. "This is the huge red flag that I see."

"Consumers not only believe that unemployment rates are going to get worse in the year ahead, but they're also expecting to be personally impacted by by weakening labor markets," Hsu said. "If people are worried about their own incomes, they're not going to feel comfortable spending."