The Fed watches inflation expectations closely. It wants them to remain “anchored.” But consumer inflation expectations have become unanchored.

By Wolf Richter for WOLF STREET.

Metrics of “Inflation expectations” are based on financial market spreads, such as the spread between the 10-year Treasury yield and the 10-year TIPS yield, or on surveys, such as the New York Fed’s Survey of Consumer Expectations (SCE), of which the latest version was released today with some bad news.

The Fed wants these inflation expectations be “well anchored” near its 2% inflation target, the same target that “core” inflation (without energy and food) has been above for over five years and has been moving further away from since mid-2025, driven by “core” services.

Inflation expectation metrics featured prominently in the minutes of the FOMC meetings and in the FOMC statements when Powell was still Chair. But the first statement released by the FOMC under Chair Warsh – that refreshingly terse statement – didn’t mention inflation expectations at all.

The last FOMC statement under Chair Powell repeated the line: “The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations….”

Whether “well anchored” inflation expectations will matter as much under Warsh as they did under Powell remains to be seen, but here they are, and they’re becoming unanchored.

Consumers’ median inflation expectations for one year from now rose to 3.67%, the highest since September 2023, when they were on the way down (green double line).

Inflation expectations for three years from now rose to 3.34%, the highest since Jun 2022 (red line). These “medium-term inflation expectations,” as they’re called in the Fed’s communications, had been “well anchored in all of 2025, but at 3.0%, which is not near the Fed’s inflation target of 2.0%. And this year they became unanchored off this 3.0% line and in June rose to 3.34%, the highest in four years.

The “Core” PCE price index – a Fed-favored inflation metric that excludes the volatile energy and food components and therefore excludes the recent energy price spike – has been accelerating since mid-2025. The year-over-year core PCE price index rose to 3.4% in May 2026 (June not yet available).

And the six-month core PCE price index, which shows the current trend better, has accelerated to 4.1% annualized, the worst in three years, and this does not include the spiking energy components (blue dotted line).

But gasoline prices no longer drove these inflation expectations in June. As gasoline prices have started to come down in June from the spike in the prior months, consumers expect gasoline prices to be just 1.5% higher a year from now.

The minutes of recent FOMC meetings under Powell had pointed to rising inflation expectations one year out as an upside risk to the inflation outlook, but had emphasized that the three-year inflation expectations – the “medium-term inflation expectations” – were still “well anchored.”

“While both market- and survey-based measures of inflation expectations indicated upside risks to the near-term inflation outlook, measures of medium- and longer-term inflation expectations remained well anchored,” said the minutes of the April 28-29 meeting.

Participants of the June 16-17 meeting – the first meeting under Chair Warsh – did not yet have today’s report. The minutes of that meeting will be released tomorrow.

But participants of the July 28-29 meeting will have seen today’s report, and something about rising medium-term inflation expectations should crop up in the minutes of that meeting.

The idea of looking at inflation expectations is that price inflation is in part a psychological phenomenon, that once consumers expect inflation, they will adjust to it and ask for appropriate raises, and then pay the higher prices, knowing that their wages will rise with the prices, rather than refusing to pay those prices and switch to a competitor or downgrade or not buy at all.

And businesses, once the inflationary mindset kicks in, want to increase prices because they’re having to pay higher wages and higher input costs, and they always want to maximize their profits, and they know they can get away with price increases because their customers expect inflation and will pay those higher prices, and so they raise prices more than needed to cover additional costs, and their profit margins soar, as we have seen in the last bout of inflation. In this scenario, inflation expectations becoming unanchored would be a factor in allowing inflation to fester.

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