💡 Can Consumers Predict Inflation?

Issue 170

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Today’s Bullets:

• The Simple Survey

• A Cold Splash of Reality

• The Fed’s Opinion

• Inflation Expectations and Bitcoin

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Inspirational Tweet:

Ah yes, the infamous University of Michigan Consumer Sentiment Survey.

After collapsing from 2020 to 2022, the indicator just flashed the most optimistic reading and one of the largest increases in history.

But what does it mean, what does the Fed think about it, and (why) should we care?

All good questions, and ones we will answer nice and easy, as always, here today.

So, pour yourself a big cup of coffee and settle into your favorite chair for a check on the pulse of the American consumer in this week's Informationist.

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🥸 The Simple Survey

Each month, the University of Michigan releases its Consumer Sentiment Index—a deceptively simple data point that punches well above its weight in market impact (read: is taken more seriously than perhaps it should).

In short, it asks a group of regular people how they feel about the economy now, and where they think it’s headed. And the results can shift yields, rattle equities, and even influence Fed decisions.

The survey includes several components:

• Current Conditions Index – how consumers feel about the economy right now

• Expectations Index – how they think the economy will perform in the near term

• 1-Year and 5 to 10-Year Inflation Expectations – what they believe will happen to prices in the near and long term

I’ve reviewed the survey in depth before, and if you are interested in a deeper dive on the mechanics of it, etc., you can find that article right here:

Are Consumer 'Expectations' Accurate?

For the TL;DR: crowd, here’s a quick summary: The University of Michigan survey is conducted monthly and reflects a semi-rotating sample of ~600 respondents. Though the sample size is tiny, it often impacts markets and policy significantly.

It sort of makes sense, as when optimism spikes, consumer spending tends to follow. When it plummets—especially in the face of economic uncertainty or inflation—market sentiment can turn quickly. And so, the index's most extreme readings have historically coincided with major economic turning points: the stagflation of the late 1970s, the Dot Com boom of 2000, and the inflation spike of 2022.

One of the most watched components of the survey—and what we will be keying next on today—is inflation expectations. On that, here’s the latest reading from this week:

What we see is the actual survey came in higher than expectations of the survey, and the survey’s inflation expectations came in under the, er, economists’ expectations.

Expectations of expectations, only on Wall Street, amiright?

In any case, here’s where inflation expectations have been in the last five years:

What we notice is a huge spike in the last few months and now some cooling off.

We’ll get into the reasons for that spike in a bit, but let’s first take a peek at the track record of this survey—see if inflation expectations actually do come to fruition, or if they’re just another imperfect and less than useful indicator for investors.

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🤨 A Cold Splash of Reality

Cutting to the chase here, Michigan’s 1-year inflation expectations are widely cited by the media and monitored by the Fed.

But are they any good at forecasting actual future inflation?

To test this out, let’s start with a look at how closely Michigan’s 1-year inflation expectations track CPI when plotted on the same axis—without any time shift. At first glance, they seem to move together quite a bit, at least directionally:

But when we shift expectations forward by a year—aligning them with the inflation they are forecasting—we see they lag inflation cycles rather than anticipate them: