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A surge in US consumers’ inflation expectations prompted by President Donald Trump’s tariffs is posing a fresh threat to the Federal Reserve’s attempt to cool price growth in the world’s biggest economy.
Wednesday’s Fed meeting falls just days after a closely followed University of Michigan measure of consumers’ longer-term inflation expectations soared to its highest level since the early 1990s. American households expect inflation to be 3.9 per cent even years in the future, compared with 3 per cent in December.
The quickening pace of households’ inflation outlook, which has been driven higher by concerns over Trump’s levies on America’s trading partners, comes as policymakers were already struggling to convince consumers that inflation would fall to the central bank’s 2 per cent target.
“It’s a linchpin talking point,” said Vincent Reinhart, a former Fed economist who is now chief economist at Mellon Investments. “Everything works when inflation expectations are well anchored. If they’re not, then you have to go to a different page of the playbook.”
“It’s the public’s vote on how [the Fed is] doing,” Reinhart added.
US rate-setters are broadly expected to keep interest rates on hold at their March vote after pausing a cycle of three straight cuts in January.
The Fed has lowered the benchmark federal funds target by 1 percentage point to between 4.25 per cent and 4.5 per cent since the summer. While policymakers have said they are in “no hurry” to cut again, markets are pricing in between two and three reductions by the end of the year.
The rise in the University of Michigan poll — a reading that Fed officials, including chair Jay Powell, have cited in the past — complicates that outlook.
“The Michigan survey alone isn’t going to determine what the Fed does this year,” said Claudia Sahm, a former Fed economist who is now chief economist at New Century Advisors. “But it does feed into it.”
The Federal Open Market Committee will publish new “dot-plots” on Wednesday, which will show how many times rate-setters expect to lower borrowing costs this year, alongside projections for growth and prices amid concerns that Trump’s policies are steering the US economy towards a period of stagflation — sluggish growth and high inflation.
Sahm added that Powell on Wednesday would “appeal to the totality of measures” — many of which still look under control.
The rises in other inflation expectations, such as the New York Fed’s poll of consumer expectations, have been relatively moderate.
“The really critical question is whether next month’s New York Fed survey shows anything remotely similar,” said Lou Crandall, of Wrightson ICAP, who views that particular measure as more “persuasive” than the Michigan poll.
The next edition of the New York Fed poll is out on April 14.
Central bankers everywhere see keeping inflation expectations “anchored” as a crucial aspect of doing their job.
If the public stops thinking the Fed can get inflation back to its 2 per cent goal and inflation expectations become “unanchored”, then a vicious circle will be created, with people demanding higher wages and businesses constantly raising their prices.
“The interesting thing about inflation expectations is that they’re not just an economic indicator, but a transmission mechanism for monetary policy,” said Crandall.
Sahm said, “They loom very large in the theory of monetary policy,” though she noted the realities of the links between expectations and actual price rises were somewhat “messier” than economic models suggested.
Inflation expectations may matter even more than usual at the moment, with the US still suffering the after effects of the worst surge in prices since the 1980s.
At 2.5 per cent, the main personal consumptions price index measure the Fed targets remains above the 2 per cent goal, after rising above 7 per cent in the summer of 2022.
“Structurally it’s quite similar, at least to some degree, to the kind of cost shocks we experienced during the pandemic,” said Isabella Weber, an economist at the University of Massachusetts Amherst. “My impression is that companies are hastening to increase prices even when they still have inventories of stuff that they imported in anticipation of the tariffs.”
Crandall said: “The fact that the University of Michigan measure is popping highlights why it’s so important. It’s a sign that after the experience of the last few years, we’re just not in the ‘anchored’ inflation expectations world that we thought we were.”
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