Inflation Expectations Skyrocket, Knee-Capping Sentiment

Inflation Expectations Skyrocket, Knee-Capping Sentiment

Consumer sentiment unexpectedly soured in May, the preliminary read on the University of Michigan’s gauge showed.

At 82.8, the headline print missed expectations and represented a retreat from April’s final read of 88.3.

Both the current conditions and expectations gauges tumbled.

Spoiler alert: The problem is inflation expectations, which appear to be coming “slightly” unmoored.

“Consumer confidence in early May tumbled due to higher inflation,” Richard Curtin, the survey’s chief economist, said Friday.

Year-ahead expected inflation absolutely surged, jumping to 4.6%, a rather alarming monthly leap from April’s comparatively benign 3.4% read (figure below).

The 1.2% monthly jump was tied for the second-most in three decades.

Perhaps more disconcerting, longer-term inflation expectations rose considerably as well, to 3.1% in May from 2.7% in April (figure below).

That’s the highest in a decade. Real income expectations now sit at the weakest in five years.

Curtin went on to note that the “average of net price mentions for buying conditions for homes, vehicles, and household durables were more negative than any time since the end of the last inflationary era in 1980.”

I suppose it’s only fitting that a week defined by the most dramatic CPI print in recent memory (and a hot read on PPI) should close on an inflationary note.

“Clearly consumers are noticing what’s going on,” ING’s James Knightley remarked. “It’s possible the recent outage of the Colonial pipeline and fears of gasoline shortages have played a part [so] we acknowledge the potential for a partial reversal next month, but we doubt it will be a full retracement.”

Curtin suggested consumer spending will hold up due to “pent-up demand and record saving balances.” Retail sales data for April disappointed on Friday and, as mentioned here, the “excess savings” narrative will likely persist until proven erroneous.

But Curtin said “the combination of persistent demand in the face of rising prices creates the potential for an inflationary psychology, fostering buy-in-advance rationales and cost-of-living increases in wages.”

On some interpretations, that could be a positive development. It would certainly rule out a descent into the deflationary abyss. But it also defines the “spiral” that some warn is imminent. The question is whether it gets out of control or, more accurately to reflect the fact that the US is the most advanced economy on Earth and prints the world’s reserve currency, whether the situation becomes uncomfortable, where that means inflation begins to materially outstrip wage gains with deleterious effects for the very people the current policy conjuncture aims to support.

Speaking of the current policy conjuncture, Curtin noted that “policy commitments to establish full employment while allowing inflation to meaningfully rise have never been attempted with the additional micro goals of equity and fairness across population subgroups.”

His contention is that “shifting policy language and even minor rate increases could douse inflationary psychology.”

That hints at the million-dollar question (or the $2-million question if inflation sets in): If prices do begin to move materially higher on a sustainable basis, will a 25bps or 50bps rate hike coupled with a taper be enough to alter expectations?

Or would that simply lead to losses for risk assets without ameliorating price pressures, thereby piling a reverse wealth effect atop higher consumer prices and making things considerably worse?

14 thoughts on “Inflation Expectations Skyrocket, Knee-Capping Sentiment

    1. Because commodities had an awful day. You’re implicitly comparing real-time, daily gyrations in markets to a comparatively static monthly survey of consumer anecdotes. Everyday Joe/Jane doesn’t even know what breakevens are.

  1. These numbers are distorted in all kinds of ways. Wall Street economists and strategists sometimes get lost in their quant analysis. Both the supply and demand sides of the economy just went throw a once in a generation if not lifetime shock. So we had poor retail sales and employment numbers and inflation on the upside. This is not hard- we won’t get a clean read on whether we are having a reflex bounce or a self sustaining recovery until the kids are back in school, and companies can reassess where they are. Don’t be surprised to see white collar layoffs and restructurings as some companies reassess where they are as things normalize more. There are more shoes to drop, as well as industries like leisure, food services and hospitality that will bounce back. We are only half way through the adjustments.

    1. After a “great” year in 2020 when “everyone rose to the occasion and performed beyond expectations in difficult circumstances,” my org has announced a 15 percent reduction in headcount through voluntary and involuntary separations (which is how I imagine Thomas Cromwell pitched his solution to Henry VIII’s Ann Boleyn problem). With each passing day, I think our robust reopening is an anomaly and not a trend.

  2. If the wealth effect is highly asymmetric (which I think it is), i.e. a large fall in asset prices from a starting point of high valuations and high leverage is far more deflationary that the creation of the bubble was inflationary (due to changes in the composition of households participating in financial risk assets during the boom and growth in financial leverage), then Fed is in a tough spot. If they bring forward rate hikes (like the forward rates market is predicting), they threaten to unleash the biggest deflationary force of all.

  3. Yes, but why should deleveraging/falling asset prices have a more deflationary effect on the downside than an inflationary one on the upside?
    It’s an interesting thought, yet I am unable to fully wrap my head around the underlying logic. For all the reasons often cited in these pages QE did not cause the dreaded (hyper)inflation. So what would be a reason for the mentioned asymmetry?

    1. My logic is participation during the life of the bubble broadens out from households with a low propensity to consume (and low effective wealth effect) to those with a high propensity to consume (and high wealth effect). Assuming those holding the bag from an asset price bubble collapse are lower income households (i.e. the last to enter into the bubble), then you could see quite a severe negative wealth effect and hit to consumer confidence.

      Housing busts tend to be particularly bad due to the leverage taken on by those with the highest propensity to consume (once in negative equity their savings rates are forced higher simply to repair balance sheets).

      1. Thanks for your explanation.
        I would agree re. the housing market, but not for financial assets (stocks). Given the inequality of the distribution of ownership imho there are simply too few “bagholders” to generate a sustained negative wealth effect.

  4. Would a reversal of the wealth effect make things worse? If it hits people with the lowest marginal propensity to consume then it likely won’t have an effect at all on the inflation situation. The “pinch” felt by those closer to the middle of the spectrum (my family included) would likely force our consumption to slow. Those at the bottom likely wouldn’t notice. Isn’t that what the fed would want in a (somewhat) runaway inflation situation?

  5. Here local tax revenues are historic in spite of reduced participation in the labor market as a result of the pandemic. Stimulus I suppose. Yet from my limited perspective that labor is still hesitant to jump back in the game. We just listed fairly decent m-f 9-5 entry level positions with bennies, and received historically low interest Meanwhile the same restaurant owners who (a few weeks ago) were bitching on the local news about how labor preferred unemployment compensation to working for them, are now singing a different tune; “baby come back, any kind of fool could $ee” i wa$ wrong and I just can’t live without you.

    As Ria indicated some shews are yet to drop.

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