Inflation alarm bells are actually getting softer

The release on Wednesday of the latest Consumer Price Index data just confirms what everyone already knows: that inflation is hovering at a 40-year high, seemingly out of control. The 9.1% June inflation rate and similar metrics help explain why consumers say they're gloomier than at any time since the 2008 financial crisis, why the Federal Reserve has made credit the tightest since 1994 and why President Joe Biden keeps sinking in public opinion polls.

But a less conspicuous set of inflation metrics deserves attention, too. Far from ominous, it shows that consumers, economists and investors anticipate a gradual return to stability and moderation.

Minutes after the Associated Press — the wholesaler of news to broadcast, digital and print media — reported on 30 June that the "key inflation gauge tracked by the Fed remains a high 6.3%," the most visible measure of investor behavior signaled the opposite. Bond investors showed that they expect inflation to cool by betting that the gap will narrow between the yield of inflation-protected US securities and ordinary Treasury bonds. The rates on these bets actually plummeted on that day, with the two-year breakeven measure falling to 3.29% from 3.45% and the 10-year rate declining to 2.34%, the lowest point since 2021, according to data compiled by Bloomberg.

The Day Bond Investors Bet Against Inflation
US 2-year breakeven inflation rate on 30 June , 2022

Consumers may be voicing alarm about inflation, but their behavior is surprisingly optimistic. Fears of continued inflation, the bane of the US economy during the 1970s before the Fed belatedly imposed the worst recession since the Great Depression, would show up statistically in higher demand for autos, washing machines and houses, in anticipation of future price increases. That's not happening, according to the University of Michigan Consumer Sentiment Index, the same indicator used to show how pessimistic Americans are even as unemployment remains just two-tenths of a percentage point above the 53-year low of 3.4%.

The Michigan measure shows that American incomes are meeting consumer needs, and that people expect gasoline prices to decline over the next five years, according to data compiled by Bloomberg.

The Michigan index measuring the expectation that gasoline prices will increase by 2027 fell 25% during the past three months to a record low since the data was first compiled in 1983. Similarly, the index measuring the chance that gasoline prices will decline during the next five years rose 67% during the past three months to a record high.

Panic at the Pump? What Panic at the Pump?
Consumer sentiment index measuring expectations that US gasoline prices will fall in the next five years.

Surging gasoline prices haven't proven as painful as their ubiquitous reporting suggests. That's because current fuel expenditures amount to 3.5% of total consumer spending compared with an average of 3.6% in monthly data going back three decades, my Bloomberg Opinion colleague Robert Burgess wrote this month. While gasoline at $5 a gallon in June was $1 more than the previous high in 2008, gasoline expenditures accounted for 4.5% of spending at that time, which means the average price of a gallon of gas would need to rise an additional 35% to about $6.60 for today's price to have the same pocketbook impact.

The 45 economists who provide quarterly inflation forecasts for Bloomberg predict that the Personal Consumption Expenditure Core Price Index, the Fed's preferred inflation metric, will decline to an average 2.9% in 2023 and 2.2% in 2024 from 4.7%. Another set of economists provides forecasts of overall US economic performance; of these 75 experts, only four predict a loss of gross domestic product in the ensuing two years, according to data compiled by Bloomberg. Most of them could be wrong, of course. But their collective sanguinity shouldn't be ignored when some chief executives dominate the headlines by asserting that a recession has already arrived.

Abby Joseph Cohen, the former chief investment strategist at Goldman, Sachs & Co. who is a professor at Columbia Business School, told Bloomberg Television in a June interview that the PCE Core Price Index is between three and four percentage points less than the CPI and declined for three consecutive months to 4.7% in May from 5.3% in February. Prices for copper and lumber, benchmarks of inflationary pressure, are down 30% and 37%, respectively, from their all-time highs in March, according to data compiled by Bloomberg.

While the University of Michigan's June sentiment index fell to a record low in June amid rising expectations for inflation, real disposable income — the money people have, adjusted for inflation — still is greater today than at any point prior to 2020, according to data compiled by Bloomberg. US GDP, similarly adjusted for inflation, increased 3.5% in the first quarter from the same period a year earlier. That sends a different message from the one conveyed by the prevalent headlines that real GDP declined 1.6% in the first three months of the year from 2021's fourth quarter, according to data compiled by Bloomberg.

If inflation is the peril of our times, investors should be demanding protection. But during the first quarter, net inflows into exchange traded funds that provide such a safe haven declined more than $12 billion to $718 million. And during the second quarter, investors were withdrawing more funds from inflation-protected securities than making deposits, according to data compiled by Bloomberg.

The bottom line: Investors are pretty sure that inflation is less of threat today than it was two years ago.

Matthew A. Winkler Matthew Winkler, Editor-in-Chief Emeritus of Bloomberg News, writes about markets. @Matthew_Winkler

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.