Decoding FOMC inflation worries: How FOMC Communication Influences US Consumer's Inflation Expectations.
The article explores how FOMC communications impact U.S. households' inflation expectations using the Advance Macro Fear Inflation Index as a tool to capture Fed's ongoing concerns about inflation.
Reading time: 4 mins.
A measure of "fear-about-inflation" has registered an uptick at the latest FOMC meetings (March-May 2024). Based on a proprietary model, the Advance Macro FOMC Fear Inflation Index gauges the element of "fear" in the Fed's non-verbal communication. The basic idea is: the higher this score, the more "concerned" the communication related to inflation (and related terms) was at that precise FOMC press conference.
Communication at press-conferences can be organically split between Introductory Statements and Q&A sessions. On this basis, each (fear) score is calculated separately for each segment. This is because Statements are usually scripted, whilst Q&A segments are not. Thus, Q&A sessions are where the true extent of the Chairman sentiment might "come out".
Considering Chairman Powell's tenure, increases in the FOMC Fear Inflation Index have been accompanied by increases in consumer inflation expectations as measured by the New York Fed's Survey of Consumers Expectations (SCE) and University of Michigan Inflation Expectation Surveys, see Figures 1 and 2 below.
In the first panel of Figure 1, we plot the FOMC Fear Inflation Index constructed using data from the Introductory Statements. In the right panel, we do the same but for the Q&A session of the press conference. These scores are plotted against the NY Fed's SCE Median one-year and three-year ahead expected inflation, as well as the median point prediction for one-year and three-year ahead inflation obtained from the NY Fed's SCE survey. It is evident that increases in the FOMC Inflation Fear Index lead households' expectations of inflation. This is especially striking in the Q&A session's scores.
For comparability, we also plot the same (fear) scores against the University of Michigan Inflation Survey, another popular measure of expected inflation (see Figure 2 below).
Why does the FOMC Inflation Fear Index anticipate changes in households' inflation expectations? The idea is that the Fed's communication can contain elements of informational advantage regarding the path of inflation that get "picked up" by the public during FOMC press conferences. In turn, households, with a lag, internalize this information and update their expectations about future inflation.
But, why does it take time for household to re-assess their expectations?
This may be because, in forming expectations, households typically rely heavily on third-party information, picking up from newspapers and various media outlets the most recent FOMC decision along with detailed commentaries. Given the time it takes reporters to elaborate and disseminate information, the lag might be quite significant. Furthermore, it might take repeated exposure or confirmation from multiple diverse media sources before households adjust their views.
Conclusion
The lag in households re-assessing their inflation expectations following FOMC communications can be attributed to the time it takes for the media to analyse and disseminate the information and for households to process and integrate this information into their expectations. The FOMC Inflation Fear Index captures these subtle signals of fear or concern about inflation, which eventually influence public sentiment and expectations once fully communicated and internalized.
The FOMC Inflation Fear Index provides early signals about the Fed's concerns over inflation. By monitoring this index, investors can anticipate potential market developments and adjust their portfolios accordingly.
The FOMC Inflation Fear Index updates are available to Central Bank E-Monitor Subscribers. Subscribe today to these updates to keep up with the index developments.
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Disclaimer: The information contained in this article is for informational purposes only and should not be construed as investment advice, financial guidance, or a recommendation to buy or sell any financial instruments. This article does not take into account any specific investment objectives, financial situation, or particular needs of any individual. Before making any investment decisions, you should seek advice from a qualified financial advisor who can take into account your individual circumstances. The authors and publishers of this material expressly disclaim any liability for any loss arising from any reliance on the information provided herein.