Under The Shadow Of Stagflation

America is experiencing an acute crisis of confidence.

As discussed here at some length last week, the world’s foremost democracy has a credibility problem at virtually every level of government. It’s immeasurably more acute now than it was six years ago, and if the country succumbs to stagflation, it’ll become more acute still.

In short: Citizens were disenchanted enough without a generational inflation shock. But when it rains it pours. Now, Americans distrust the money too.

The pervasive sense of angst started showing up months ago in the University of Michigan’s consumer sentiment survey, which hit a record low in June. On a delay, the Conference Board’s gauge is beginning to crack. The headline print for this month, 98.7, wasn’t all that bad when taken in isolation. Certainly, it’s nowhere near as dour as the Michigan survey (figure below).

Do note that outside of 2020 (i.e., stripping out the impact of the pandemic), June’s headline confidence print was the lowest in some six years.

But it was the expectations gauge that raised eyebrows on Tuesday. At 66.4, The Expectations Index now sits at the lowest in almost a decade. That doesn’t bode well for consumer spending, to put it mildly.

The proximate cause of consumers’ dismal outlook was, of course, inflation. And “in particular” the surge in food and gas prices. “Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as growing risk of recession by year-end,” Lynn Franco, Senior Director of Economic Indicators at The Conference Board, said Tuesday.

Consumers were more pessimistic about business conditions, the labor market and their own personal financial prospects. Although purchasing intentions weren’t singularly grim, they’ve receded steadily over the course of 2022, a trend Franco cautioned “is likely to continue as the Fed aggressively raises interest rates to tame inflation.”

That kind of color doesn’t augur well for Jerome Powell and his colleagues or, more to the point, for public faith in the institution they represent. One way or another, the Fed will find itself at the center of a political firestorm later this year. The midterm elections promise to be especially contentious even as US politics goes, and while it’s entirely possible the economy could be in a recession by then, it’s not at all likely that inflation will be materially lower. Americans will vote under the shadow of stagflation.

In addition to the already daunting task of reining in inflation expectations at a time when everything costs more, the Fed may very well discover that attack ads created for the midterms stoke inflation fears, thereby working at cross purposes with monetary policy’s efforts to allay public concern.

“We see further increases in food and gas prices — especially if crude oil prices increase to $140/bbl, as our commodity strategists forecast — as the main risk that consumers’ long-run inflation expectations continue to shift upwards, but another risk is that high inflation is set to feature prominently in political advertisements ahead of the midterm elections in the next few months, especially since polling data suggests that high inflation is a major vulnerability for Democrats that Republicans intend to feature heavily in congressional campaign ads,” Goldman’s Joseph Briggs said, in a recent note.

For the first time since the 80s, a non-trivial percentage of Americans see inflation as the most important issue facing the country (figure on the left, above). At the same time, gas prices are even more important to voters than gun violence and abortion, a state of affairs which is discouraging in its own right.

“The upcoming political cycle will therefore likely keep inflation top of mind, and consumers might respond to these campaign messages by revising inflation expectations higher,” Goldman’s Briggs went on to say, in the same note.

If you’re wondering whether politicians are that crass — that self-serving — that they’d risk undermining the Fed’s inflation-fighting efforts and chance an irreversible unanchoring of inflation expectations just to score a few political points ahead of the midterms, the answer is a resounding “yes.”

And that, coming full circle, speaks loudly to why everyday Americans are so disenchanted with anything and everything, every day.