New index shows US inflation expectations shifting higher

FILE PHOTO: People count money at the Macy's Herald Square store during the early opening of Black Friday sales in the Manhattan borough of New York.
FILE PHOTO: People count money at the Macy’s Herald Square store during the early opening of Black Friday sales in the Manhattan borough of New York November 26, 2015. REUTERS/Andrew Kelly

March 8, 2022

By Howard Schneider

WASHINGTON (Reuters) – US one-year inflation expectations have spiked since the Russian invasion of Ukraine, and the longer-term outlook has also started to improve, a development likely to be closely watched by the Federal Reserve as it Struggling to keep price pressure down Control.

A new daily index released Tuesday by the London-based ICE Benchmark Administration (IBA) showed the expected pace of consumer price increases over the next year eased to 5.24% on February 7, from 3.5% on February 1. March will rise. The Index is based on the approximately $300 billion monthly market in US Treasury inflation-linked bonds and the $100 billion monthly market in inflation swap contracts.

Inflation, which is expected over an extended 10- and 6-year horizon, has also risen sharply since the start of the Ukraine war, with rates on Monday of around 2.43% and 2.73% respectively, well above the Fed’s annual inflation target Index shows.

Chart: ICE Inflation Expectations Index:

Longer-term inflation expectations are closely monitored by the Fed to show whether its policies are keeping the inflationary psychology in check. If longer-term expectations continue to rise, it would indicate a loss of confidence in the Fed’s ability to control inflation – and make inflation harder to beat even without painfully large and rapid rate hikes.

“If this number continues to rise, those setting monetary policy will notice that higher trend inflation expectations are being priced into the system, and that could impact decision-making,” said IBA President Timothy Bowler, a former US Treasury Department official .

Next year’s inflation will be “strongly influenced by commodity prices” and oil prices in particular, he said. The question the Fed now faces is whether this will “suddenly affect average inflation rates” expected for years to come.

Measuring expectations and assessing the psychological impact on the prices set by firms and the wages accepted by workers is a widely studied and highly controversial topic. Market measures, which derive inflation rates from various selling prices of securities, are one tool. Other measures are based on consumer or other surveys.

But however it is measured, policymakers generally believe that in addition to controlling near-term inflation outcomes, they are concerned with keeping long-term expectations stable and close to the Fed’s 2% target. Indeed, a key to the Federal Reserve’s success in controlling inflation since the 1980s has been public confidence in its ability and willingness to do so.


February was a tough month for the US Federal Reserve on this front.

Headline inflation is currently well above target and the Fed plans to hike rates at its monetary policy meeting next week and likely later this year in hopes of lowering the headline figure before expectations change.

However, the timing and pace of these increases in borrowing costs have become increasingly uncertain following the invasion of Ukraine, which caused a conflict-related oil price shock similar to that of the 1970s. During that decade, US inflation faltered, forcing the Fed to raise interest rates so much that it triggered a recession.

Central bankers have a well-known willingness to “see through” perceived temporary increases in energy and commodity prices, even large ones.

But Fed Chairman Jerome Powell told lawmakers in Congress last week that the shock of Russia’s military action could be a “game changer” for world markets. If this translates into a steady rise in inflation expectations, it could lead to more aggressive monetary tightening.

IBA is a unit of Intercontinental Exchange, a company that develops and sells a variety of market analysis tools.

The Index of Inflation Expectations is being released free of charge, Bowler said, to provide a daily overview of an issue that could shape central bank policy debates in the coming months.

Other organizations publish data on inflation expectations, such as B. the 10-year expectations provided daily by the St. Louis Fed. Fed officials in Washington combine a broader set of household surveys and market data into a single inflation expectations index, but it’s only updated every three months.

Events are moving faster than that.

Oil prices have risen more than 25% since the start of the Ukraine war and should keep consumer inflation higher this year than it otherwise would have been. The consumer price index is already topping a 7% year-on-year increase, and data to be released on Thursday is expected to push February prices up 7.9% from a year earlier.

(Reporting by Howard Schneider; Editing by Paul Simao) New index shows US inflation expectations shifting higher

Caroline Bleakley

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