The Fed's worst inflation fears may be coming true as consumers lose faith in long-term prices

Key Points:

• The overall consumer sentiment index has fallen for the third consecutive month to a record low, even below levels seen during the 1970s oil crisis, while inflation expectations have risen due to the Iran war and the closure of the Strait of Hormuz keeping energy prices high.
• Year-ahead inflation expectations increased to 4.8% in May from 4.7% in April, and long-term expectations jumped to 3.9% from 3.5%, surpassing the 2024 range of 2.8% to 3.2%, with the rise driven notably by independents and Republicans.
• The surge in inflation expectations raises concerns about a potential cycle where consumers demand higher wages, perpetuating inflation, and risks undermining confidence that inflation will eventually subside, a scenario that worries Federal Reserve officials.
• Fed Governor Chris Waller highlighted that repeated price shocks can alter consumer psychology, leading to heightened inflation expectations even if shocks are considered temporary, and emphasized that while the Fed is monitoring the situation, immediate rate hikes are premature.
• The persistence of higher inflation reflects ongoing challenges from geopolitical tensions and past trade policies, with the Fed committed to acting if inflation expectations become unanchored but currently preferring to observe how events and data develop.