Deciding the Next Step for the Federal Reserve: Rising U.S. Household Inflation Expectations vs. Falling Financial Market Inflation Expectations, Who is Wrong?

U.S. inflation expectations are diverging, and the Federal Reserve faces high uncertainty.

On April 16, JPMorgan's latest research report indicated that different inflation expectation indicators are currently sending completely different signals, putting the Federal Reserve in a policy dilemma.

The report pointed out that various survey indicators (households, businesses, professional institutions) generally show a significant rise in short-term inflation expectations, while inflation expectation indicators based on financial markets remain relatively stable or even decline. This divergence may force the Federal Reserve to adopt a more cautious policy stance.

Divergence in inflation expectation indicators amplifies uncertainty in the Federal Reserve's policy path

The report shows that the Federal Reserve's general inflation expectation index (ICIE) is expected to rise from 2.08% in the first quarter of 2025 to 2.13%, and may continue to rise in the second quarter, suggesting increased inflation pressure.

Historical data shows that for every 0.1 percentage point increase in ICIE, it typically indicates a 1 percentage point rise in core PCE inflation.

Meanwhile, household sector surveys show a significant rise in inflation expectations.

The report indicates that the long-term inflation expectations for 5-10 years from the University of Michigan survey have seen the largest monthly increase in 46 years, reaching the highest point since May 1991, while the short-term inflation expectation for one year has surged to 6.7% in April due to tariff concerns, marking a new high in over 40 years.

In the business sector, the Richmond Fed's survey shows a surge in manufacturing price payment expectations, but limited increases in price reception, indicating pressure on profit margins; the U.S. NFB small business survey shows a slight increase in small businesses' pricing plans.

In stark contrast to various survey data, inflation expectation indicators based on financial markets, such as Inflation Swaps and the implied breakeven inflation rate from TIPS (Treasury Inflation-Protected Securities), have recently declined.

For example, the Atlanta Fed's survey of business expectations for unit cost changes shows only slight upward pressure; the Cleveland Fed's business expectations CPI inflation indicator is even declining.

Federal Reserve Governor Waller previously cited this data, believing that the market views tariffs as "one-time price level changes," and long-term inflation expectations remain "well-anchored."

However, the report also warns that such data may be influenced by market liquidity, risk aversion, and oil price fluctuations, and their trends may not accurately reflect reality:

Liquidity differences: The depth and liquidity of the TIPS market are far inferior to that of the regular Treasury market. When the market is under pressure and risk aversion leads to a surge in funds into Treasuries, TIPS demand may not keep up, artificially lowering the implied inflation compensation (i.e., market inflation expectations).

Recession fears overshadow inflation concerns: Tariffs, as a negative supply shock, have a complex impact on bond yields. The market seems to focus more on pricing the recession risks that tariffs may trigger rather than inflation risks, especially for long-duration assets

Oil Price Sensitivity: Even long-term market inflation indicators (such as 5-year forward 5-year inflation swaps or breakeven rates) are surprisingly highly sensitive to spot oil prices. In the monthly data over the past 15 years, these long-term indicators have a regression fit of over 82% with Brent crude oil prices. The recent weakness in oil prices may have contributed to a decline in market inflation expectations.

The report analysis states that divergent signals from households and the market may force the Federal Reserve to adopt a more cautious policy stance. Currently, the market generally expects that the Federal Reserve's interest rate cuts may be delayed until after September this year.

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