Fed attacks bring worries about inflation expectations

The outlook for where inflation might be headed suggests a slight uptick ahead. The Labor Department’s producer price index, which measures wholesale inflation, rose from 2.8% in October, on an annual basis, to 3% in November. 

You might be thinking: November is so last year. But we’re still catching up from the government shutdown. 

Here’s the thing about where inflation is headed: It’s as much about how consumers feel as it is about what wholesalers are paying. And consumers have been feeling pretty pessimistic. Add to that the uncertainty surrounding Federal Reserve independence, with the Justice Department subpoenaing Chair Jay Powell, and you’ve got increased risk of a self-fullfilling inflation spiral. 

“If you expect inflation to be worse in the future, you want to avoid those future price increases, and you might do that by buying things now, when you still think they are relatively cheaper,” said Joanne Hsu. She directs the monthly surveys of consumers at the University of Michigan. 

If enough people rush to buy things, they’ll boost demand and push up prices. Conversely, workers may also demand higher wages if they think life is going to cost more in the future. 

“If enough workers do that, and firms feel like they are able to pass on those labor costs in the form of higher prices, then that is what becomes a self-fulfilling prophecy,” Hsu said.

Right now, the University of Michigan’s survey finds long-run inflation expectations aren’t terrible: 3.4%. 

But it could get worse, especially if people lose faith that the Federal Reserve will act in the interest of keeping inflation in check, and think that it’s influenced by politics instead. 

“And this way, it could result in high inflation expectations, and it's very difficult to put it back, so to say, in the Pandora box,” said Yelena Shulyatyeva, senior U.S. economist at The Conference Board. 

It’s not just consumer expectations we have to worry about.

Financial analyst Stephen Kates at Bankrate said bond markets could get skittish too, if they think the Fed’s short-term actions are counterproductive and will fuel inflation in the long term. 

“If there's expectations that inflation is going to be higher in the future, then long term bond yields are going to rise, borrowing costs are going to go up, and we can get into this cycle that can be a bit of a flywheel that's hard to stop,” he said.

Long-term bond yields are what determine what consumers end up paying — in credit card rates, car loans, and mortgages.