Americans' expectations of inflation have surged, raising concerns about long-term economic stability. According to the latest Michigan survey, inflation expectations for the next 5 to 10 years increased to 3.9% in March from 3.5% in February, marking the largest month-over-month rise since 1993. This shift reflects a broader trend of rising inflation expectations, as Americans also anticipate higher inflation in the coming year, with expectations climbing to 4.9%, the highest level since November 2022. These developments occur against a backdrop of significant changes in U.S. trade policies and economic strategies since President Trump assumed office in January, leaving American consumers and businesses on edge.
The Federal Reserve is grappling with this new reality, as officials express concern over the potential for "un-anchored" inflation expectations, which could complicate their efforts to manage the economy. The twin threats of rising inflation and weaker economic growth loom large, reminiscent of a period known as "stagflation." Fed Chair Jerome Powell faces the challenge of reassuring an anxious public about how the central bank plans to address these issues.
Rising Inflation Expectations
The University of Michigan's latest consumer survey highlights a troubling trend of rising inflation expectations. Over three consecutive months, there have been unusually large increases of 0.5 percentage points or more in these expectations, indicating a shift in Americans' perceptions of prices. The survey reported the largest month-over-month increase seen since 1993, signaling growing unease among consumers.
Fed officials are acutely aware of the implications of these changing perceptions. When inflation expectations become "un-anchored," it complicates the central bank's ability to control inflation effectively. This phenomenon can influence consumer behavior, leading to self-fulfilling prophecies that drive prices higher.
"These days, higher tariffs and immigration policies are often discussed and thought likely to increase prices, cool aggregate demand and possibly soften employment." – St. Louis Fed President Alberto Musalem
Economic Challenges and Policy Changes
Since taking office, the Trump administration has implemented structural changes to trade policy, the federal workforce, immigration, and America's relationships with its allies. These shifts have added an element of uncertainty to the economic landscape, causing concern among consumers, businesses, and investors.
Analysts have pointed to the combination of higher inflation and weaker growth this year as a potential harbinger of stagflation. The Organisation for Economic Co-operation and Development (OECD) has echoed these concerns, noting that the global economy is trending toward stagflation. This toxic duo poses significant challenges for policymakers, who must navigate the delicate balance between stimulating growth and controlling inflation.
"A lot of what we’re contending with is in the inflationary direction, but we’re also expecting to see a moderation in consumer spending, coming from the fact that the jobs market is continuing to cool off," – Sarah House, senior economist at Wells Fargo
Fed's Response and Future Prospects
Fed Chair Jerome Powell is tasked with communicating how the central bank will address these dual threats. The Federal Reserve had previously achieved a "soft landing," successfully reducing the highest inflation in four decades without triggering a recession. However, with rising inflation expectations and sluggish growth prospects, Powell must reassure the public that the Fed remains vigilant and prepared to adapt its monetary policy if necessary.
"It’s hard to say how these opposing forces will balance out in the end, and that’s what the Fed is having to consider right now," – Tom Bruce, macro investment strategist at Tanglewood Total Wealth Management
Consumer spending has already shown signs of decline, with a drop-off in January attributed to harsh cold weather conditions. As inflation expectations continue to climb, there is growing pressure on the Fed to respond appropriately to prevent further economic disruption.
"They’re data dependent, so they’re not making any moves at this meeting, but Powell will have to express that they’re watching the situation closely and staying prepared to make a policy change if necessary." – Tom Bruce, macro investment strategist at Tanglewood Total Wealth Management