Someone Is Wrong About Inflation. Is It You Or The Fed’s Preferred Gauge?

“Adding to consumers’ concerns about a significant expected drop in income growth, year-ahead inflation expectations rose sharply, putting extra pressure on consumers’ abilities to maintain their living standards”, Richard Curtin, chief economist for the University of Michigan consumer sentiment survey, said Friday, in the color accompanying the final read for May.

Consumers’ mood darkened a shade from the preliminary report, as the headline index moved down to 72.3 from the 73.7 initial print. The market was expecting the gauge to edge slightly higher.

The quote from Curtin is notable. Earlier this month, I flagged a steep rise in consumers’ inflation expectations as a possible early warning sign, even as I remain squarely in the deflation camp vis-à-vis the impact of COVID-19. Both one-year and longer-run expectations moved up dramatically, and the final report for May saw them tick higher still.

That contrasts with a slump in the Fed’s preferred inflation gauge (which accompanied Friday’s data deluge) and the latest CPI numbers, which showed core prices falling the most on record, even as grocery bills surged the most in 46 years.

And that latter bit is probably key. Because nobody was driving or flying or engaging in the activities where the virus’s deflationary impact was most acute, consumers instead experienced the inflationary impulse on food prices.

Bloomberg’s Katherine Greifeld noticed the disparity. “Kind of neat to watch core PCE readings and U. of Mich inflation expectations head in different directions”, she remarked.

Yes, “neat” indeed.

In Friday’s release, Curtin says “more widespread price discounting as well as low interest rates have helped to improve buying plans, but those plans still remain well below the levels recorded three months ago”.

With uncertainty around the future of the economy running high and the jury still out on how many of the “temporarily” unemployed will become permanently jobless, expectations for rising prices are insult to injury.

Market-based measures of inflation expectations are tame, to say the least, and there’s more than a little skepticism among analysts and traders around the likelihood that the Fed will succeed in hitting its target anytime soon, given the deflationary impact of the virus and a dollar which, recent stumbles notwithstanding, has remained stubbornly resilient.

Of course, inflation has a self-fulfilling component to it. And some say the market is underappreciating the chance of price instability once the initial deflationary impulse from COVID-19 abates.

Consumers reported hearing more negative economic news in May than at any other time in history, the additional color from the final University of Michigan sentiment report says.

Respondents also downgraded their views about longer-term economic prospects, with 50% anticipating bad financial times over the next five years. That’s the second-worst reading since Trump became president.

Read more: Why Morgan Stanley Sees ‘The Return Of Inflation’ After Coronavirus Crisis


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2 thoughts on “Someone Is Wrong About Inflation. Is It You Or The Fed’s Preferred Gauge?

  1. CPI is inaccurate during lockdowns. We have all seen the news of “the 90% economy” abroad. What if CPI continues to track the wrong basket under “the new normal?” In that case we’d see low measured inflation and loose policy would exacerbate felt inflation.

    Data-driven! Got to do what the numbers tell us, right?

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