Inflation Expectations: Is Wall Street Conceding To Main Street?
Since the end of 2007 one of the key areas of our firm's focus has been on "inflation expectations". We first started to pay attention to both market-based (which represents Wall Street) and survey-based (which represents Main Street) measures of this data a little over a year ago, when then-FOMC Member Michael Moskow stated in an April 2007 speech in Chicago:
"...if firms and workers expect inflation to be high, they will want to keep up with the general increase in prices and costs. As a result, they will set higher prices and wages or build in plans for automatic increases. In this way, higher inflation expectations can become self-fulfilling. That is, they can lead to a persistently higher inflation rate, instead of simply a temporary increase."
Since then, the Fed has increasingly been mentioning inflation expectations as a key factor in their determination of future US monetary policy.
In previous blog postings dating all the way back to February (when we launched this blog), we have regularly been displaying various survey-based measures of these inflation expectations, pointing out that Main Street's expectations were becoming "unmoored" (to use the Fed's words), and stating that this was probably keeping the Fed up at night. However, we also noticed that market-based expectations indicated that Wall Street was remaining relatively sanguine in its own expectations for inflation.
We discussed this difference in perception between Main Street and Wall Street in our May 14th Commentary entitled, April CPI Data: Main Street Should Eventually Trump Wall Street. In that report, we said that we anticipated that Main Street's expectations for inflation, which were based on the realities of headline inflation and its effects on how the average American lives, would eventually bleed into Wall Street, which was clearly more focused on core inflation and the Fed's hopes for inflation to eventually "moderate".
Now, through Friday, there is some tangible evidence that Main Street's escalating inflation expectations are indeed starting to influence Wall Street's market-based measures. The chart below displays the implied 5 year forward inflation rate, which is one market-based indication of what Wall Street thinks about inflation. It indicates what the market thinks the 5-year inflation rate will be starting five years from now.
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