There are three inflation gauges most investors keep an eye on. There’s the widely-followed Consumer Price Index (CPI) published by the Bureau of Labor Statistics (Labor Department), which was up 9.1% for the 12 months ended June – the highest in over 40 years. Then there’s the Producer Price Index (PPI), also from the Bureau of Labor Statistics, which is considered a measure of wholesale prices manufacturers pay each other. It was up 11.3% (annual rate) in June – also the highest in years but slightly below the 11.6% print in March.

Then there’s the Personal Consumption Expenditures Index (PCE) created and published by the US Bureau of Economic Analysis (Commerce Department), which rose at a record annual rate of 6.3% in May, the latest data available. The PCE is the Fed’s favorite inflation gauge because, among other things, it includes prices paid by non-profit institutions to one another. The PCE and the CPI are often quite different because they are calculated using different formulas and components.

Yet there’s a fourth inflation indicator which I consider just as important as the CPI, PPI and PCE – the Consumers Expectations Survey, published by the New York Federal Reserve. The Consumer Expectations Survey asks Americans where they expect inflation to be a year from now. This indicator also hit a record high of 6.8% in June, slightly higher than the 6.58% print for May shown in the chart below.

With consumers lifting their expectations for inflation over the next year, they believe things like gasoline, medical care, rent, and tuition will also increase over the next 12 months. Interestingly, however, they expect food prices will moderate in the next year – I’m not sure why.

I wanted to bring this indicator to your attention because the survey plays a key role in determining how Fed policymakers respond to the inflation crisis. That is because actual inflation depends, at least in part, on what consumers think it will be. It is sort of a self-fulfilling prophecy – if everyone expects prices to rise by 3% in the year, this signals to businesses that they can increase prices by at least 3%. Workers, in turn, will want a 3% pay raise to offset the rising costs.

The steeper-than-expected increase in inflation expectations in May actually prompted Fed officials to approve the first 75-basis point interest rate hike since 1994 on fears that higher prices were becoming entrenched. Then, of course, the Index hit another record high in June which means the Fed will almost certainly raise its benchmark interest rate by another 75-basis points when its policy committee meets again on July 26-27.

There is speculation in the financial markets that the Fed Open Market Committee (FOMC) might raise the Fed Funds Rate by a full 1% at its July meeting. I don’t see that, but we can’t rule it out. Comments by Fed Chairman Powell and others on the Committee suggest another 75-basis point hike near the end of this month, and then they will reassess.

Unless inflation shows signs of peaking and tipping over, I also expect the Fed to raise its key rate at each of the final FOMC meetings this year in September, November and December. With inflation rising more than the Fed expected, Chairman Powell recently said that “strong action was warranted.”

Following the Fed’s latest policy meeting on June 14-15 when the FOMC voted to raise the Fed Funds Rate by 75 basis points, Chairman Powell said the goal was to get inflation expectations back down to 2%. He stated: “One of the factors in our deciding to move ahead with 75 basis points today was what we saw in inflation expectations. We’re absolutely determined to keep them anchored at 2%. That was one of the reasons—the other was just the CPI reading.”

With consumer inflation expectations at 6.8% a year from now, I believe the Fed will have a near-impossible job to get expectations back to 2% anytime soon. Mr. Powell’s comments above and elsewhere confirm the Fed knows it’s behind the curve in fighting inflation, and it should have been raising its key lending rate earlier. Now the risk is the Fed will raise rates too high in the coming months and spark a recession late this year or next year.

While Chairman Powell has good intentions, the Fed has a long history of reacting late and then reacting too long. We can only wait and see what happens this time. I’ll keep you posted, as always.

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