Unanchoring of Inflation Expectations

Macro Perspectives: Tue 08 Mar 22

As we discussed on Thursday, "if sanctions were placed on Russian energy exports, there's no telling how high the crude oil market might spike."

On that note, Pelosi launched a trial balloon, just as futures markets opened, saying that Congress was "exploring legislation to ban import of Russian oil." Oil traded as high as $130 at the open.

This comes as the national average price for gas had already climbed above $4 a gallon - we're a nickel away from the highest national average price on record. The record high was in 2008, and the national average sniffed around $4 again in 2011 and 2012. Importantly, this $4 has proven to be a psychological level that changes consumer behaviours.

What did consumers do? They pulled back. "Gas guzzling" SUV's were dumped. They gave them to the government in exchange for a check ("cash for clunkers"), and/or they simply just stopped driving as much (as you can see in the graphic below).

Now, if high oil prices persist (which seems to be the highest probable scenario), it will hurt consumer spending (in at least some areas), but it also feeds into an already hot wage pressure situation, and it feeds into inflation expectations. The latter happens to be the Fed's biggest fear (i.e. the "unanchoring" of inflation expectations).

With that, what happens when people start expecting the price of everything to run away - they chase prices (higher, and higher).

That would push the Fed into the ring of a dog-fight. As we'll see at the end of the week, inflation is already proving to be persistent, and steadily climbing toward double-digits. The last time the Fed was in this situation (early 80s), they had to move short-term rates ABOVE, the rate of inflation to finally bring it under control.