INFLATION EXPECTATIONS KEY POINTS:
- May consumer inflation expectations for the medium term climb to 4% from 3.4% in April.
- Rising inflation outlook can beget a vicious cycle and translate to higher observed inflation over the longer term.
- The New York Fed Survey does not provoke much volatility as the market remains focus on the FOMC policy announcement this week.
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As the economic recovery gains momentum in the United States aided by the Covid-19 vaccination campaigns, more Americans believe consumer prices will trend upwards over the medium and long term. According to the Federal Reserve of New York, 12-months consumer inflation expectations rose to 4% in May from 3.4% in April, its highest level since the institution began conducting the survey in 2013. Meanwhile, the three-year outlook climbed five tenth of a percent to 3.6%, the second highest reading in the series.
The worsening inflation outlook can reduce household confidence levels, hindering economic performance and weakening the economic growth. Most importantly, if left unchecked, rising consumer inflation expectations can feed into wageand price-setting decisions, translating into higher observed inflation and making the vicious cycle harder to dislodge over the longer horizon.
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In any case, as shown in the 3-minute USD Index chart below, the data released this morning did not cause much volatility, as investors remain focused on the FOMC monetary policy decision scheduled for Wednesday afternoon. No changes to interest rates or the quantitative program are expected, but the institution could gently tweak its forward guidance and revise some macro variables in the June SEP to take into account the latest economic developments. In this regard, traders will keep a close eye on the Fed’s assessment of inflation following the hottest headline CPI reading in more than a decade in May.
If the central bank shows increased concern about broadening inflationary pressures and indicates that it has begun preliminary discussion on the possible mechanics of tapering asset purchases, US treasury yield could inch higher, lifting the dollar in the forex market. This does not seem the most likely outcome at the moment, but it should not be ruled out entirely, as the Fed can sometimes surprise.
On the other hand, if the institution led by Jerome Powell continues to characterize the rise in consumer prices as transitory and reiterates that now is not the time to discuss stimulus withdrawal as the economy has not made “substantial progress,”, nominal bond yields could struggle to bounce back, reinforcing the dollar weakness. At this juncture, a dovish outcome appears probable.
US DOLLAR CHART (3 MINUTES)
EDUCATION TOOLS FOR TRADERS
—Written by Diego Colman, DailyFX Market Strategist
Follow me on Twitter: @DColmanFX