As gasoline prices surge and U.S. Treasury yields rise, the Federal Reserve's long-maintained 'anchored inflation expectations' faces a severe test. The Fed is concerned that if the public loses confidence in the 2% target, it may trigger a wage-price spiral.
For a long time, the Federal Reserve has been committed to guiding the public's "inflation psychology," striving to keep price fluctuations within a predetermined trajectory. However, with rising gasoline costs driving up household inflation expectations and the increase in U.S. Treasury yields reflecting bond market concerns, the Federal Reserve is facing a daunting challenge in managing expectations.
Due to the war between the U.S., Israel, and Iran, international oil prices surged by over 50% in just four weeks, stabilizing at above $100 per barrel. Previously, Federal Reserve officials generally believed that the public's long-term inflation expectations were "anchored," meaning they were confident in the central bank's ability and determination to achieve the 2% inflation target. But now, as rising oil prices quickly translate into living costs such as airfare, the Federal Reserve is closely monitoring various survey data and market indicators to prevent any systematic deviation in inflation psychology.
Philadelphia Fed President Anna Paulson stated bluntly at a recent meeting: "Although long-term inflation expectations are currently aligned with the 2% target, after several years of above-target inflation, combined with the current price shock, these expectations have become extremely fragile."
Market sentiment fluctuations have already manifested through financial data. Last week, demand for U.S. Treasury auctions was weak, with yields rising due to inflation concerns; subsequently, a survey by the University of Michigan showed a jump in American households' price expectations for the next year.
At the press conference on March 18, Federal Reserve Chair Powell was repeatedly asked about the economic risks brought by geopolitical conflicts. He expressed his core concern: After five years of inflation deviating from the target, would the new round of energy shocks become the straw that breaks public confidence?
Powell stated: "We have experienced tariff shocks, pandemic shocks, and now continuous and severe energy shocks. Successive external disruptions can easily destabilize inflation expectations. We are keeping a close watch on this and will spare no effort to ensure the stability of expectations."
The historical lesson is particularly profound. The "inflation psychology" of the 1970s once led businesses and households into a vicious cycle of frantic bidding wars and demands for higher wages. At the time, due to a lack of strong policy credibility, the Federal Reserve ultimately had to resort to highly disruptive interest rate hikes, pushing the economy into a deep recession to barely suppress prices.
The current situation has forced monetary policy orientation to shift towards a "hawkish" stance. Investors have largely ruled out the possibility of the Federal Reserve cutting interest rates this year and have begun betting on the probability of rate hikes. Some Fed officials have even started hinting at the option of raising rates, attempting to bolster the central bank's anti-inflation credibility through tough rhetoric.
Although the concept of "inflation expectations" remains controversial in academic circles and difficult to measure precisely, the sense of crisis within the Federal Reserve has significantly risen. Fed Governor Michael Barr pointed out that while some long-term indicators (such as five-year inflation-protected securities) still appear stable, fluctuations in consumer survey data cannot be ignored.
Barr emphasized: "We are in a unique window period where inflation has lingered at high levels for five years, and short-term expectations are again on the rise. I am very concerned that a new round of price shocks could completely reverse long-term inflation expectations, and we must remain absolutely vigilant against this possibility."
As fluctuations in oil prices continue to disrupt the stock and bond markets, developments in the Middle East have become a core variable influencing the direction of U.S. monetary policy. For the Federal Reserve, the outcome of this 'psychological battle' will directly determine whether the U.S. economy can avoid repeating the mistakes of the 1970s.
Editor/Rocky