Yesterday’s FOMC minutes made clear that the Fed’s eye is now firmly on future inflation expectations. And it’s not likely to see them drop any time soon, according to Deutsche Bank’s Joseph LaVorgna and Carl Riccadonna.
That’s because very rarely due future inflation expectations fall, and Deutsche Bank analysts believe their unlikely to do so now, unless fuel prices fall.
Thus, in our view the probability of a further increase in longer term inflation expectations is rising—particularly if near-term inflation expectations continue to drift higher. As the chart below illustrates, 1-year inflation expectations are significantly influenced by CPI energy, and hence retail gasoline prices. While some policymakers expect recent price pressures to be transitory as a result of slack in the labour and product markets, one can observe that 1-year inflation expectations generally do not decelerate unless energy prices lead the way. So unless oil prices dip sufficiently to unwind the recent uptrend in retail gasoline prices, inflation expectations are unlikely to retreat.
So if you’re hoping for a Fed retreat from recent hawkish rhetoric, you should hope they take their eyes off this ball.
Photo: Deutsche Bank