Oh, boy. We did not get a good datapoint this morning. And you probably won't hear much about it, but it's a crucial datapoint for the Fed.
We just got the preliminary consumer sentiment reading from the University of Michigan at 10 a.m. ET, and at first glance it seems encouraging; sentiment "surprised on the upside" with a five-point jump to a reading of almost 65. Remember, this reading hit a record low in mid-June as pump prices soared to all-time highs.
So naturally, consumer sentiment is rebounding as gasoline prices have fallen. The problem? Inflation expectations are rebounding, too. And not the near-term ones that are most sensitive to food and energy costs. The longer-term ones that tell the Fed that inflation is at risk of becoming entrenched.
The single scariest datapoint for Fed, I would argue, is what U.S. consumers think inflation will be over the next five-to-ten years, i.e., what they think will be "normal." This rose to 3% in today's report, the highest since gasoline prices peaked last June! That's right--consumers today, after all that's happened in recent months and with all the talk of looming recession, have as high a view of "normal" future inflation as they did back in June when prices were still surging.
I haven't seen Fed futures markets yet, but savvy investors should be very concerned about this if they were hoping for a quicker Fed pause, or smaller and fewer hikes. Recall that the first time the Fed did a 75-basis-point rate hike last year was the Wednesday after this very same report showed a jump in long-term consumer inflation expectations.
That's right--on Friday, June 10th, we got the very bad CPI report, but 90 minutes later we also got the very bad sentiment report that showed long-term inflation expectations spiking to 3.3% (I wrote about it here). That afternoon, I said I wouldn't be surprised if the Fed upsized to a 75-basis-point hike at the looming meeting--which is exactly what they telegraphed to The Wall Street Journal that weekend, followed by the first of what would end up being four 75-basis-point rate hikes on June 15th.
If you wanted the Fed to pause now, you'd need today's reading to show a big drop in long-term expectations, to something more like 2.5%. That clearly did not happen. We saw a similar stubbornness in the New York Fed's own survey, released earlier this week, showing that three-year expectations are still at 3% and five-year expectations rose one-tenth to 2.4%.
So our Steve Liesman is absolutely right in his reporting today that, as far as markets are concerned, "the Fed's beatings will continue" in the form of additional rate hikes. Which is too bad, because I would put way more credence on the collapse being signaled in forward-looking bond market indicators than I would in these "coincident" consumer reports.
But the Fed has decades of research and empirical work on how inflation expectations are one of the main channels for influencing actual future inflation, and Fed officials talk about it all the time. What we don't hear so much about is their research on how bond futures markets are excellent predictors of GDP, which itself can be the overriding factor in how employment and inflation will behave over time.
The best the bulls can hope for is that consumers' inflation expectations collapse as much in the coming months as the bond market's already have. This week's data suggests they shouldn't hold their breath.
See you at 1 p.m!
Kelly