The Fed is terrified that Americans may become accustomed to higher inflation. Maybe it’s already happening

Washington, DC
CNN
—

A worrying signal is beginning to emerge for the Federal Reserve.

The Fed is closely monitoring several risks that could make its task of taming inflation more difficult, such as overheated consumer demand keeping some upward pressure on prices and the potential effects of geopolitical tensions in the Middle East on oil prices.

But the US central bank is also paying close attention to whether Americans remain confident that inflation will eventually return to normal. This faith seems to be eroding.

The latest University of Michigan consumer poll released Friday showed that Americans’ long-term inflation expectations rose to 3.2% this month, the highest level since 2011.

These perceptions may continue to worsen the longer it takes the Fed to return inflation to its 2% target. Fed officials don’t expect inflation to reach 2% until 2026, according to their latest economic forecasts issued in September.

If there’s one thing that would make the Fed shake in its boots, it’s worsening inflation expectations.

“If we find that consumers or businesses are already starting to feel that the level of long-term inflation… is creeping up, and if that is their expectations, then we have to act and we have to get that under control.” Federal Reserve Chairman Rafael Bostic told Bloomberg earlier this month.

If Americans lose confidence that inflation can ever return to normal, that would prompt the Fed to tighten monetary policy further — either by raising interest rates or keeping them high for much longer than expected.

The Fed’s benchmark lending rate is currently at a 22-year high, and investors are already expecting the central bank to keep interest rates higher for longer.

“I worked at the Fed for six years, and if inflation expectations rise and are not under control, the Fed will definitely act,” Luke Tilley, chief economist at Wilmington Trust Investment Advisors, told CNN.

“That’s the only thing that’s giving them trouble sleeping at night. They’re not losing sleep over recessions because they come and go, but they’re losing sleep over long-term inflation expectations that are drifting upward,” he said.

It is unclear whether inflation expectations will continue to deteriorate, and the Fed is looking at a wide range of surveys, not just the University of Michigan polls. But the survey conducted by the university is one of the most closely followed by investors and economists.

The Fed is particularly focused on longer-term inflation expectations, and Fed Chair Jerome Powell makes a point of mentioning the state of Americans’ inflation perceptions at every news conference after officials set monetary policy (which happens eight times a year).

During his final post-meeting news conference earlier this month after officials voted to keep interest rates steady, Powell said “longer-term inflation expectations appear to remain well anchored.”

But the clock is ticking, inflation is still well above 2%, and some economists believe the last mile of the Fed’s inflation battle may be the toughest.

“I remain willing to support a hike in the federal funds rate at a future meeting if incoming data indicates that progress on inflation has stalled or is insufficient to bring inflation down to 2% in a timely manner,” Fed Governor Michael Bowman, a Fed official. Federal. The most hawkish officials said last week at a New York Bankers Association forum in Palm Beach, Florida.

The key word there is “timely”.

Steady inflation may “cannibalize” inflation expectations or cause a continued deterioration in Americans’ perception of inflation. But it is unclear how long it will take for sustained high inflation to cause this.

“The Fed is very pessimistic” in expecting inflation not to reach 2% until 2026, Tilly said.

Ultimately, the Fed just needs to maintain confidence that the inflation monster will one day go away, and the steady deceleration of inflation over the past year so far has helped in that regard, according to the Federal Reserve Bank of New York.

A recent analysis by the bank of consumers’ views on inflation showed that “consumers today know enough about the Fed to recognize its policies as the most important factor behind the recent and expected future decline in inflation.”

The Fed may need to continue to prove that it is making progress in its historic battle against inflation.

“I think 2% is just a number because what matters most is the direction of travel and not where they get to before the trip ends,” Drew Matos, chief market strategist at MetLife Investment Management, told CNN. “The Fed really wants people not to expect inflation to be at 4% forever.”

So, what has kept inflation expectations in check throughout this period? Matos said it might just be nostalgia.

“People want to believe that the future will be like the good old past because it is something the mind can comprehend on its own,” he said. “They’re trying to jog their memory of when things were affordable and what the Fed really needs to pay attention to is the risk of an inflation shock right now.”

If you’re someone who likes to plan ahead with your taxes, this week the IRS released new inflation-adjusted income tax brackets and standard deduction amounts that will be in effect for the 2024 tax year.

Translation: These are the numbers that will be relevant on the tax return most Americans file in early 2025, my colleague Jane Sahadi reports.

The IRS makes inflation adjustments annually for tax brackets, the standard deduction, and some other tax breaks.

For individuals and married couples filing separately, the new federal standard deduction will increase to $14,600, up from $13,850 this year.

For married couples filing jointly, the standard deduction will rise to $29,200, up from the current $27,700.

For people filing as heads of household, the standard deduction would be $21,900, up from $20,800 today.

Most bloggers claim the standard deduction. Others will itemize their deductions because combined, they add up to more than the standard deduction.

For example, if you’re a single filer and your mortgage interest, charitable contributions, and the allowable portion of your state and local income taxes add up to more than $14,600 in 2024, you should probably itemize your deductions to save more on taxes.

Monday: Earnings from Tyson Foods. Federal Reserve Governor Lisa Cook delivers her remarks.

Tuesday: Earnings from Home Depot. The US Department of Labor will release the Consumer Price Index for October. Federal Reserve officials Philip Jefferson, Michael Barr, Loretta Mester, and Austin Goolsby deliver remarks. The National Federation of Independent Business releases its Small Business Optimism Index for October. China’s National Bureau of Statistics releases October data on industrial production, retail sales, investment in fixed assets and the unemployment rate for that month.

Wednesday: Profit from the target. The UK Office for National Statistics releases inflation data for October. The US Department of Labor will release the Producer Price Index for October. The US Department of Commerce releases retail sales figures for October. Federal Reserve Vice Chairman for Supervision Michael Barr delivers his remarks.

Thursday: Earnings from Walmart, Macy’s, and Gap. The US Department of Labor announces the number of initial unemployment claims for the week ending November 11, along with export and import prices in October. The Federal Reserve releases October numbers on industrial production. The National Association of Home Builders releases its housing market index for November. Federal Reserve officials Lisa Cook, Michael Barr, Loretta Mester, John Williams and Christopher Waller provide their remarks.

Friday: The US Department of Commerce publishes October data on housing construction and building permits. San Francisco Federal Reserve Bank President Mary Daly delivers her remarks.