Today we get the May’s University of Michigan Consumer Sentiment report. You would expect inflation expectations to ease given the recent positive developments on the trade front right? I think that’s the consensus even though we don’t have consensus numbers for the inflation expectations data.
What if they increase further though? That would be a surprise for me, and I think the risk of expectations having de-anchored would be high and make the Fed even more uncomfortable. The Fed has been placing a great deal on inflation expectations lately and if you expect growth to pick up in the next months, then you would also expect the central bank to be very cautious on rate cuts.
Cutting now could exacerbate higher inflation expectations and contrary to Trump’s belief, long term Treasury yields would rise further. The problem for the Fed is that they haven’t reached the target yet and they will now face better growth expectations, a potential surge in economic activity (the Philly Fed yesterday could have been a signal), tax cuts, deregulation and let’s not forget that we still end up with 10% tariffs.
To sum up, there’s a risk that an increase in inflation expectations could trigger a hawkish repricing in interest rates expectations and that will have a repercussion on different asset classes. The more straightforward reaction to a hawkish repricing would be long USD and short long term Treasuries. But I can see also a pullback in the stock market as the positioning is getting overstretched
