Consumer sentiment rises despite worsening inflation expectations

REAL ECONOMY BLOG | October 14, 2022

Authored by RSM US LLP

U.S. consumer sentiment rose for the fifth straight month to 59.8 in October but a worsening inflation outlook clouded the otherwise positive news, the University of Michigan reported on Friday.

Solid income growth in a tight labor market is keeping household financial conditions strong as sentiment over the current economic situation surged on the month.

For example, consumers felt more optimistic in October when it comes to buying big-ticket items like new vehicles and major household items.

But it was a different story when it came to inflation expectations, which showed troubling signs with the 12-month expectation rising for the first time since March.

Americans now expect inflation to be at 5.1% after the next 12 months, 0.4 percentage points higher than in September. The inflation outlook for the next five to 10 years is also up to 2.9% from 2.7%. Much of the increase came from the top two thirds of the income distribution.

While both the short-term and long-term inflation expectation indicators were below recent highs, they added to the mounting concerns that inflation will become entrenched, as the Federal Reserve minutes showed this week.

For the Fed, the clock is ticking faster as inflation has been with the economy for a year and a half.

If inflation continues to be elevated for too long—about two years, according to our estimate—the risk only grows that inflation will bleed into wages as workers bargain for new contracts and businesses adjust their plans.

The takeaway

That is the reason to believe that the Fed will be more aggressive with its policies, starting with another jumbo 75 basis-point rate hike next month with more coming next year. Those increases would bring the Fed’s policy rate to a range between 4.75% and 5% despite the economic pain those hikes would bring.