Inflation Expectations Surge Despite Signs of Cooling Economy, Suggesting Stagflation

The Federal Reserve building in Washington, on March 18, 2008. Jason Reed/Reuters

U.S. household inflation is expected to rise over the next 12 months, despite signs of a slowing economy, suggesting stagflation.

The University of Michigan’s preliminary release of its overall consumer sentiment index for April came in at 63.5, up from 62.0 in March. Economists polled by Reuters had forecast a preliminary reading of 62.0.

Rising inflation expectations may prompt the Federal Reserve to reassess its inflation expectations by maintaining higher interest rates for an extended period of time, which may tank the economy into a downward spiral.

The consumer sentiment index surveys how Americans feel about their finances, as well as the overall economy, with many households being rather pessimistic since last summer, largely due to high inflation.

The report follows the Federal Reserve Bank of New York’s report on April 10 regarding retail sales, which showed the sector declining much more than had been expected.

Both reports show weary consumers still facing high inflation and elevated interest rates, but the labor market appears to be strong, even as it has begun to slightly soften in recent weeks.

American Optimism Dims on Economy

“Rising sentiment for lower-income consumers was offset by declines among those with higher incomes,” said Joanne Hsu, director of the University of Michigan’s Surveys of Consumers.

“While consumers have noted the easing of inflation among durable goods and cars, they still expect high inflation to persist, at least in the short run.”

The survey’s reading of one-year inflation expectations rose to 4.6 percent from 3.6 percent in March, the largest month-over-month increase since May 2021.

Inflation expectations have become worse, even though the latest recent government reports in April showed easing price pressures.

The five-year inflation outlook remained unchanged at 2.9 percent for the fifth month in a row, staying within the narrow range of 2.9–3.1 percent range for 20 of the last 21 months.

However, the index of current economic conditions rose from 66.3 last month to 68.6 in April, which is well below normal.

American consumer sentiment picked up in April, from 59.2 in March to 60.3 this month, and is also extremely low by historical standards.

The economy has been sluggish due to a sharp increase in interest rates by the Fed as it tries to tackle inflation.

The central bank said on April 13 that policymakers expect a mild recession later this year, but the markets also expect another round of interest-rate hikes when it meets again in early May.

Many economists have been highly critical of Fed Chairman Jerome Powell’s hardline stance on raising interest rates and his continuous public statements that the economy will have a soft landing.

“Yes, so about inflation coming down. Michigan one-year ahead inflation expectation just rose the most since 2021, back at 4.6 percent This is the one that Powell looks at, right?,” stated investor and analyst, Jeroen Blokland, in a tweet.

Banking Sector Still Facing Threat of Stress

Meanwhile, rising stress on the U.S. banking sector could make it harder for consumers and businesses to borrow loans.

JPMorgan Chase and Citigroup both posted strong first-quarter earnings last week, allaying some fears about the state of the banking industry following the sudden collapse of both Silicon Valley and Signature Bank of New York last month.

Larger banks have benefited from the flight of deposits from smaller, regional banks, as well as higher interest rates that allowed them to charge customers higher interest for loans.

However, noted economist Mohammed El-Arian has warned, in an op-ed in the Financial Times, that the crisis with the regional banks will lead to a credit contraction for regular Americans and small businesses. He said that risks still remain, despite the industry avoiding a near collapse last month.

“Success in dealing with the immediate threat of bank runs, as welcome as this is, has not eliminated the risk that the U.S. banking tremors pose for the economy as a whole,” said El-Arian.

“Rather than bet on early rate cuts, markets should be encouraging the Fed to complete its inflation-reduction task before trying to offset a credit contraction that will only play out over a number of quarters. Failing that, we will be dealing with a higher probability of the even trickier challenge of stagflation.”

Reuters contributed to this report.