Sentiment Down Fourth Month

The University of Michigan reports Consumer Sentiment Down Fourth Month

Consumer sentiment fell for the fourth straight month, plunging 8% from March. While the April decline in current conditions was modest, the expectations index plummeted with drop-offs in personal finances as well as business conditions. Expectations have fallen a precipitous 32% since January, the steepest three-month percentage decline seen since the 1990 recession. While this month’s deterioration was particularly strong for middle-income families, expectations worsened for vast swaths of the population across age, education, income, and political affiliation. Consumers perceived risks to multiple aspects of the economy, in large part due to ongoing uncertainty around trade policy and the potential for a resurgence of inflation looming ahead. Labor market expectations remained bleak. Even more concerning for the path of the economy, consumers anticipated weaker income growth for themselves in the year ahead. Without reliably strong incomes, spending is unlikely to remain strong amid the numerous warnings signs perceived by consumers.

Year-ahead inflation expectations surged from 5.0% last month to 6.5% this month, the highest reading since 1981 and marking four consecutive months of unusually large increases of 0.5 percentage points or more. This month’s rise was seen across all three political affiliations. As seen in the chart, inflation expectations evolved with major trade policy announcements this month. After the April 9 partial pause in tariff increases, inflation expectations ebbed but remained substantially elevated relative to March. Long-run inflation expectations climbed from 4.1% in March to 4.4% in April, reflecting a particularly large jump among independents.

Inflation Expectations Highest Since 1981

The above chart does not appear to match the report, but that’s because it a daily chart not the final monthly reading.

To repeat … “Year-ahead inflation expectations surged from 5.0% last month to 6.5% this month, the highest reading since 1981 and marking four consecutive months of unusually large increases of 0.5 percentage points or more.

Do Inflation Expectations Matter?

I have repeatedly made the case, no they don’t, and I am not changing my tune here.

However, the Fed disagrees (despite massive evidence from their own studies), and their opinion matters more than any facts.

The Fed will be particularly wary of long-term expectations and this statement “Long-run inflation expectations climbed from 4.1% in March to 4.4% in April, reflecting a particularly large jump among independents.“

Inflation Expectations Don’t Matter

Every FOMC meeting the Fed Chair, currently Jerome Powell, makes a fool of himself with nonsensical discussions on inflation expectations.

How can they matter? If you do think they matter, then answer this simple Q&A.

Consumer Inflation Expectations Q&A

• If you think the price of rent will jump next year, will you rent two houses now to beat the rush?
• If you think the price of rent will fall next year, will you hold off renting until rent falls?
• If you think the price of medical care will jump next year, will you have two operations now to beat the rush?
• If you think the price of medical care will fall next year, will you hold off on a needed operation?
• If you think the price of a vacation will jump next year, will you have two vacations this year and none the next?
• If you think the price of a vacation will drop next year, will you have no vacations this year and two the next?
• Will you stop eating? Eat more?
• If you car breaks down will you fix it twice? Wait until next year?

OK, maybe you wait for a sale to buy a coat. But you probably don’t by two. And if your coat rips, and you need one, you may not wait at all.

You can’t do much about electricity bills, home insurance, auto insurance, or gasoline.

Up and down the line there is not a damn thing you can do about 90 percent of what you buy. Rent alone is 35 percent of the CPI.

Businesses Inflation Expectations

Grocery stores can’t do anything at all, for obvious reasons.

Manufacturers can order ahead, and did to beat tariffs, but now they now have big inventories.

How many cars can dealers fit on their lots? And what if consumers don’t buy?

Dealers can only hold a few month’s inventory, assuming storage space, but at a cost and risk of declining prices if consumers throw in the towel.

Fed Study Agrees

No study should be needed to prove the logic of what I just stated. However we do have a study, and it’s by the Fed.

Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?)

Please consider Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?) by the Federal Reserve.

Mainstream economics is replete with ideas that “everyone knows” to be true, but that are actually arrant nonsense.

The direct evidence for an expected inflation channel was never very strong. Most empirical tests concerned themselves with the proposition that there was no permanent Phillips curve tradeoff, in the sense that the coefficients on lagged inflation in an inflation equation summed to one.

Finally, even if one is willing to entertain the idea that in some vague, mushy sense concern over costs and demand by individual firms facing fixed prices leads to a dependence of aggregate inflation on expected inflation, we are still left with the conclusion that short-run expectations should be the ones that are most important.

One might also be uneasy about policymakers’ relying too heavily on the assumption that inflation’s long-run trend will remain stable going forward so long as measured long-run inflation expectations do. Even if every one of my preceding arguments is judged by the reader to be completely unconvincing, it nevertheless remains the case that we have nothing better than circumstantial evidence for a relationship between long-run expected inflation and inflation’s longrun trend, and no evidence at all about what might be required to keep that trend fixed (beyond that it might involve keeping actual inflation from moving up too much above two percent on a sustained basis).

[Mish note: The lpreceding two paragraphs are a direct criticism of Fed policy as practiced by every Fed chair and people dismiss these reports without reading. The next paragraph is a hoot as well.]

Or would you justify the view that expectations “matter” by pointing to the inflation experience of the 1960s and 1970s, even though that period provides no actual evidence that workers or firms tried to boost their wages or raise their prices in anticipation of future price or cost changes?

Amusing Quotes

• Expectations are by definition a force that that you intuitively feel must be ever present and very important but which somehow you are never allowed to observe directly: R. M. Solow (1979)
• Pure economics has a remarkable way of pulling rabbits out of a hat. It is fascinating to try to discover how the rabbits got in; for those of us who do not believe in magic must be convinced that they got in somehow: J. R. Hicks (1946)
• Don’t interfere with fairy tales if you want to live happily ever after: F. M. Fisher (1984)
• Few things are harder to put up with than the annoyance of a good example: Mark Twain, The Tragedy of Pudd’nhead Wilson (1894

Do Inflation Expectations Matter?

I have discussed inflation expectations at least ten times over the years.

Here’s one from 2023 when I tangle with Bill Fleckenstein regarding the question How Do Inflation Expectations Impact Wages and Future Consumer Inflation?

Fleckenstein is an inflation expectations believer.

Phillip’s Curve Nonsense

Also see Yet Another Fed Study Concludes Phillips Curve is Nonsense

Despite the Fed’s own studies, every Fed president still believes in the Phillip’s Curve and Inflation Expectations.

They have been trained to believe nonsense.

Asset Price Expectations

Asset price expectations are another matter. That’s why we have bubbles and crashes.

People will buy houses and stocks if they think prices will rise. People don’t by stocks if they think they will fall.

But asset prices are not in either the CPI or PCE price indexes. Fostering asset prices bubbles is a constant mistake by the Fed.

The one place expectations do matter is in asset bubbles, and it’s the only place the Fed doesn’t look!

Inflation Expectation Reality

Inflation and media reporting of it drives expectations, not the other way around.

That’s a good thing for the Fed right now, even if the Fed is too clueless to believe the obvious (and their own studies).

However, doesn’t matter doesn’t mean won’t happen. No one knows what Trump will do. So no one can rule out stagflation or asset bubble deflation, or anything in between.

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