A look at one of our preferred measurements of inflation expectations implies that the risk of a sustained outbreak of inflation is receding just as another set of inflation data—the Consumer Price Index for June—is set to publish on Tuesday.
Inflation expectations play an important role in spending and investment decisions, in addition to determining actual inflation.
If prices are expected to increase dramatically, consumers might decide to buy immediately, pressuring prices even higher in the short term. But if prices are expected to decrease, consumers might forgo purchasing, further depressing prices as supply outpaces demand.
We think that data will show that the recent burst of inflation has either reached, or is about to reach, its apex.
We think that data will show that the recent burst of inflation has either reached, or is about to reach, its apex and then begin an uneven journey over the next 12 to 18 months back toward long-term trends.
The Aruoba Term Structure of Inflation Expectations (ATSIX), compiled by the Philadelphia Federal Reserve, indicates subdued expectations for inflation in 10 years’ time converging on the Fed’s 2% target.
Expectations for inflation a year from now, though, are more volatile, moving in sync with the latest swings in inflation as the business cycle progresses and as the price of oil moves up and down.
The full range of inflation expectations from one year out to 10 years shows that they have moved higher since the end of last year. That’s to be expected as vaccinations paved the way for increased economic activity and as revived demand and supply-chain bottlenecks contributed to spikes in product prices.
The result is the expectation for modestly higher rates of inflation, reaching 2.35% next year before dropping to 2.25% in 10 years.
These moderate expectations should allow for rational levels of spending and investment and allow the economy to progress from recovery mode to an outright expansion.
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