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Inflation expectations haven't been this low in decades

Rayhanul Ibrahim
Crushed. (Image: REUTERS/Marcos Brindicci)

The Fed’s time table to hike rates may have just been pushed back.

New data from the University of Michigan revealed that consumer expectations for inflation over the next 5 to 10 years fell to a record low of 2.3% from 2.5% a month ago. This data series goes back to 1979.

"These low levels of inflation expectations have occurred even though actual inflation has been increasing over the past few months and they will likely make the Fed more cautious when considering the next rate hike," JPMorgan's Dan Silver said.

Expectations for inflation are tumbling. (Image: Barclays)

This is problematic for the Fed, because their “dual mandate” is to maximize employment and keep prices stable. The latter goal generally means keeping inflation low, but not low enough that they risk deflation. 

Meanwhile, the Federal Reserve has been looking to raise interest rates, after having kept them at record lows from the financial crisis up until the end of 2015. Historically, raising interest rates has had the effect of decreasing inflation.  Therefore, the Fed must be very cautious right now, or they risk lowering consumer expectations for inflation even further. 

"Chair Yellen admitted that 'some measures of longer­term inflation expectations have moved a little lower over the past couple of years' in her speech earlier this week; today’s move lower may exacerbate those concerns," Barclays' Jesse Hurwitz said.

If inflation expectations fall too much, or hit deflation levels, consumers are likely to start spending less, reasoning that their cash will gain value if they just hold onto it.  This will lower demand, hurting employment, and in theory it could make prices tumble even further.

Combined with the poor jobs report from May, this has essentially wiped out the possibility for a rate hike when the Fed meets next week. It will also likely push economic forecasters to move the timing for the next rate hike forward.

Going forward, low inflation expectations run the risk of making the Fed hostage to market expectations, rather than economic data.  If the Fed moves faster than the market is expecting, consumer expectations for inflation may decrease even further. 


Rayhanul Ibrahim is a reporting intern at Yahoo Finance.

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