Fed inflation expectations hit 3.67%, highest since September 2023

The Federal Reserve Bank of New York's Survey of Consumer Expectations showed one-year inflation expectations climbed to 3.67% in June, the highest since September 2023, complicating the central bank's policy outlook even as Chair Kevin Warsh noted inflation risks have eased.

"The persistence of elevated inflation expectations at the consumer level suggests the Fed's final mile back to 2% remains the hardest," said Thomas Simons, US economist at Jefferies. "This data point reinforces the case for patience on rate cuts."

The reading rose from 3.51% in May and marks the fourth consecutive monthly increase, according to the New York Fed survey released Tuesday. The five-year inflation expectations measure edged up to 2.89% from 2.85%. The data comes as the federal funds rate sits at 5.25% to 5.50%, unchanged since July 2023, with OIS markets pricing a 41 percent probability the Fed holds rates steady in September, up from 32 percent a week ago, according to CME FedWatch.

The divergence between consumer inflation expectations and the recent moderation in market-based inflation measures creates a policy dilemma for the Fed. If consumer expectations remain sticky above 3.6 percent, the central bank may need to maintain its restrictive stance longer than markets currently anticipate, delaying any potential rate cuts into 2027. The Fed's next policy decision is July 29-30.

Warsh, speaking at the European Central Bank's forum in Sintra, Portugal, on Wednesday, said "inflation risks" had "come down," pointing to the retreat in energy prices after the US and Iran signed an interim peace agreement last month. Oil prices have slid back to pre-conflict levels, with WTI crude trading near $70 a barrel, down from highs above $90 during the Iran conflict.

However, the New York Fed survey captures a different narrative at the household level. Consumers reported expecting gasoline prices to rise 4.1 percent over the next year, while rent expectations climbed to 7.3 percent. Food price expectations held steady at 5.2 percent. The survey also showed a deterioration in household finance expectations, with the perceived probability of missing a minimum debt payment rising to 11.2 percent from 10.6 percent.

The last time one-year inflation expectations exceeded 3.6 percent was in September 2023, when the reading hit 3.69 percent. At that time, the Fed had just held rates steady after hiking to the current 5.25 percent to 5.50 percent range in July 2023. The S&P 500 fell 4.9 percent over the following month as markets repriced the rate outlook.

The inflation expectations data follows a mixed batch of labor market indicators. The ADP employment report showed private employers added 98,000 jobs in June, below the 118,000 consensus estimate. Challenger, Gray & Christmas reported 45,849 job cuts in June, down 53 percent from May's 97,006. The June nonfarm payrolls report, due Thursday, is expected to show 190,000 jobs added, according to a Bloomberg survey.

The ISM manufacturing index slipped to 53.3 in June from 54 in May, while its prices-paid component fell sharply to 73 from 82.1, offering some evidence that goods-price inflation is moderating. The services ISM, released Monday, showed the prices-paid index dropping to 67.7 from 71.3.

For the Fed, the tension between easing goods-price pressures and sticky consumer inflation expectations will be the central debate at the July meeting. Warsh has indicated he may take a different approach to forward guidance than his predecessor, potentially doing away with providing policy road signs for markets altogether. A task force is reviewing how the central bank approaches communication and economic assessments.

This article is for informational purposes only and does not constitute investment advice.