International Forecaster Weekly

DESPITE FED RATE HIKES, Inflation Expectations at Record Highs

Even though the Fed has started hiking interest rates to rein in inflation running at a 4-decade high, consumers and investors think price rises will be tough to slow.

A new reading of consumer sentiment on Friday from the University of Michigan confirms that Americans’ inflation expectations remain at their highest level since 1981—and continue to grow.

The survey’s chief economist Richard Curtin observed that inflation is the chief culprit in consumers’ rising pessimism, with expectations of a 5.4% rise for the year ahead.

Guest Writer | March 29, 2022

By Dave Allen for Discount Gold & Silver

Even though the Fed has started hiking interest rates to rein in inflation running at a 4-decade high, consumers and investors think price rises will be tough to slow.

A new reading of consumer sentiment on Friday from the University of Michigan confirms that Americans’ inflation expectations remain at their highest level since 1981—and continue to grow.

The survey’s chief economist Richard Curtin observed that inflation is the chief culprit in consumers’ rising pessimism, with expectations of a 5.4% rise for the year ahead.

Interestingly, stock traders are said to be pricing a rate of over 8.5% through the end of April—even before the Fed considers following through on suggestions of a 50-basis point rate hike at its May meeting.

As show above, inflation expectations five years out—often referred to as the “5-year breakeven" rate—also kept climbing this past week, hitting a new record high at 3.6%.

Matt Phillips notes that some of this swell is related to the war in Ukraine in addition to related energy and commodity cost surges. But prices were rising well before Putin’s late February invasion.

Phillips writes that economists follow inflation expectations because they often act as a self-fulfilling prophecy; i.e., they matter because actual inflation depends, in part, on what we expect it to be.

If everyone expects prices to rise, say, 3% over the next year, businesses will generally want to raise their prices by at least 3%. Similarly, workers and their unions will want pay raises of at least 3%.

In other words, as David Wessel and Tyler Powell have found, if inflation expectations rise by one percentage point, actual inflation will tend to rise by one percentage point as well—thus fulfilling the prophecy.

Curtin said, “Strong job growth will continue to put upward pressures on wages, resulting in higher income and stronger job prospects. 

“This strength will then act to expand consumer demand and ultimately lead to another cycle of price and wage increases.”

He added that it’s these factors that reflect the conditions necessary “for the development of inflationary psychology as a self-fulfilling prophecy.”

Looking farther down the road, consumers’ longer-term inflation expectations — over a 10-year horizon — are lower but at a record high of 3.03%.

Higher Rates Could Hammer Housing Market

Nowhere could a self-fulfilling prophecy have a bigger impact than on the already crazy housing market.

Neil Irwin writes that the housing market this spring is looking like a head-on train wreck because of powerful forces crashing into each other.

Interest rates on home mortgages have already spiked faster than they have in decades, reducing affordability, especially for first-time buyers. Plus, builders can't get enough supplies to build houses more quickly.

Yet, strong personal income growth and seemingly unstoppable demographic forces have been pushing high demand over the past year and a half.

Irwin believes it’s likely there will continue to be a gap between supply and demand—"making for a frustrating market for all involved.”

The rise in mortgage rates in recent weeks has confounded industry experts and is outside the range of any recent experience.

The average rate on a 30-year fixed-rate mortgage was 4.42% last week, according to Freddie Mac—up 18% from 3.76% just three weeks earlier. That's the biggest three-week rise since 1987. The rate was 3.05% just three months ago, 31% lower than last week.

But those numbers are already outdated, based on mortgages locked in last Monday through Wednesday. By the end of last week, Mortgage News Daily's average came in at 4.95%.

The speed and the scale of rising mortgage rates mean that a family that can afford a $2,000 monthly mortgage could have borrowed $424,000 at the beginning of March—but only $375,000 at Friday's 4.95% rate.

And that affordability factor gets worse the farther down you go on the household income scale.

Higher Rates Reflect a Fed Shift

While it has raised its short-term Fed Funds rate by a mere quarter-point, long-term rates like mortgages are shaped by investors' expectations of the future path of the economy and Fed policy. 

And, as noted above, that has turned notably higher since December.

The supply side of the market has its own troubles, as homebuilders have not been able to deliver enough houses to address pent-up demand, holding back sales volumes. KB Home’s CEO Jeff Mezger said last week, "Our biggest challenge today is completing homes, not selling them." 

Among the materials in short supply, COO Bob McGibney singled out steel ducts needed for HVAC systems, ovens, garage doors, windows, cabinets and siding. He added that "we expect shortages of materials will stay with us throughout this year."

It will be a bumpy path as the housing market seeks a new balance. Rising mortgage rates will limit what buyers can offer, yet it is high prices that incentivize suppliers to ramp up production.

Meanwhile, homeowners with a low mortgage rate may be more reluctant to sell and give up the benefit of a rate that’s below 3%, further hampering supply.

Irwin argues that if the Fed is going to get inflation under control in the short term, it may still have to break, or at least slow, the expectation that prices are going to continue creeping steadily higher.

That will likely mean hiking rates more quickly, and higher, than people have been expecting, with more and more traders pricing in a minimum 50-basis point increase in May—maybe even higher. A lot of investors won’t love that.

Thus, we may end up with less supply and transaction volume, making America's latest housing crisis worse.

Since the beginning of the year, gold is up 7%, from $1,828 to $1,958 at today’s opening. Silver has risen 10%, from $22.81 to $25.04 this morning.

Don’t wait for ramped-up economic uncertainty and geopolitical volatility to cause gold and silver to move higher; think about locking into today’s prices now.