American Inflation: The Real Culprit Behind Rising Prices

Rising Inflation and Consumer Anxiety
Federal Reserve Chair Jerome Powell's press conferences, once pivotal market-moving events, have recently drawn less attention—overshadowed by the presence of Donald Trump in the White House. However, a fresh surge in inflation has brought prices back into sharp focus. In January, the "core" consumer price index—excluding volatile food and energy costs—rose at an annualized rate of 5.5%. Former Treasury Secretary Larry Summers has called this the "riskiest period for inflation policy since the early Biden administration," referencing the era when inflation hit a four-decade high.

A Surge in Inflation Expectations
Even more troubling is the shift in consumer expectations. Preliminary data from the University of Michigan’s consumer survey for February shows that the median expectation for price growth over the next year has reached 4.3%. Since Trump’s election, this figure has surged by 1.7 percentage points—the largest three-month increase since 1979, when inflation spiraled into double digits. Market indicators echo this trend: the one- and two-year breakeven inflation rates—derived from the difference between nominal and inflation-adjusted Treasury yields—have increased by 1.7 and 0.8 percentage points, respectively, since November.

The Unusual Divergence from Historical Trends
Historically, consumer inflation expectations align closely with two key factors: current inflation rates and petrol prices. Typically, these variables explain around 80% of the fluctuations in short-term inflation forecasts. However, this year, the usual predictive model has become unreliable. If pre-Trump patterns had held, median consumer inflation expectations would be nearly a percentage point lower. A similar, though less pronounced, deviation is evident in market forecasts.

Tariff Fears Driving Inflation Concerns
This gap appears to be fueled by uncertainty over Trump's tariff policies. The standard deviation in consumer inflation expectations—measured by the University of Michigan survey—is at its highest level since 1980. Many Americans seem to take Trump's warnings at face value when he states that "prices could go up somewhat short term." Those opposed to tariffs anticipate inflation nearing 5% within a year, driving the overall expectation higher.

A Self-Fulfilling Prophecy?
Consumer inflation expectations often shape actual inflation outcomes. When workers anticipate rising costs, they demand higher wages. At the same time, shoppers, fearing future price hikes, rush to make purchases, boosting demand and pushing prices up further. This dynamic appears to be taking hold: in January, American wages increased at an annualized rate of 5.9%. Additionally, more than 20% of respondents in the University of Michigan survey believe now is a good time to buy expensive items, such as electronics and furniture, due to expected price increases. This is the highest proportion in three decades.

The Fed’s Dilemma
Federal Reserve officials are closely monitoring these developments. Lorie Logan, president of the Dallas Federal Reserve, has warned that once inflation expectations spiral out of control, restoring stability often comes "only at a great economic cost." She emphasized that current inflation uncertainty serves as "a reminder that expectations won’t stay anchored forever on their own."

Diverging Long-Term Inflation Expectations
Long-term inflation expectations remain uncertain. The "five-year, five-year forward" measure—favored by central bankers—has remained largely stable. However, other indicators show a gradual rise. Market-based forecasts for the five-year breakeven inflation rate are creeping up, and median consumer expectations for five-year-ahead inflation have climbed to 3.3%, surpassing their peak during the recent inflationary surge.

The Partisan Divide on Inflation
Political affiliation now plays a role in inflation expectations. Democrats anticipate an average 4.2% annual price increase over the next five years—a strikingly high projection. Research indicates that Republican concerns over pandemic-era inflation contributed to inflationary pressures in subsequent years. Now, Trump’s repeated calls for Powell to cut interest rates are amplifying Democratic anxieties. While the president relishes challenging bureaucrats, he may find that undermining the Fed carries unintended consequences.

As inflation fears mount, the Fed faces a delicate balancing act—taming price expectations without derailing economic growth. The coming months will determine whether these concerns prove self-fulfilling or if inflationary pressures can be reined in before they escalate further.