The inflation genie is moving to the White House

The latest inflation data isn’t actually all that bad.

Americans are growing concerned about sticky inflation, and President-elect Donald Trump needs to make sure that he doesn’t fan those anxieties with untimely tax cuts or tariffs that juice the costs of imports.

The latest data suggest why it’s a particularly tricky time in inflation psychology. A report Wednesday showed that the consumer price index rose 0.39% in December, the biggest one-month increase since February. Although much of the heat came from famously volatile categories, they are also the areas that hit consumer psychology most directly: pump prices and supermarket items. Supply concerns and a cold snap contributed to a 4.3% increase in the energy commodities index, and food at home jumped for a second month, as bird flu contributed to a surge in egg prices.

By and large, these aren’t categories that economists consider “core,” and they probably don’t say much about underlying trends in overall inflation. But it’s also true that idiosyncratic supply shocks are starting to feel a little too commonplace to many households. Some months the heat comes from auto insurance, others it’s airline tickets. In recent months, Egg Armageddon has entered the mix. Most Americans don’t care about the particulars of the disinflation rug-pull du jour — there just always seems to be one.

Economists believe that inflation expectations are a self-fulfilling prophecy: Consumers that expect higher prices may just accept them as a given instead of taking their business elsewhere. At an extreme, they might also demand higher wages to keep up, which drives corporate costs higher and prompts companies to hike prices even further (the infamous wage-price spiral scenario). This economy is far from a wage spiral, but you wouldn’t want expectations to get further out of control.

A University of Michigan survey published Friday showed that US consumers expect prices to climb at 3.3% over the next 5-10 years, the most dire long-term inflation expectations since 2008. A Federal Reserve Bank of New York survey published Monday showed consumers expect 3% inflation over the next three years, the highest in that measure since November 2023. Granted, these surveys can suffer from respondents’ imperfect understanding of the questions and a variety of biases. (The Michigan survey showed that Democrats suddenly became inflation doomers last month, while Republicans miraculously became more optimistic. What could have prompted this change?)

Morning Consult and Federal Reserve Bank of Cleveland Research produce a weekly measure that attempts to quantify 12-month inflation expectations “indirectly” to adjust for some of the problems inherent to these surveys. Instead of asking about inflation, the Morning Consult-Cleveland Fed question asks consumers how their incomes would have to change to make them “equally well-off,” given their expectations about prices in the next 12 months. That series suggests that inflation expectations, while not worsening, have gotten stuck in an elevated range. Breaking it down by demographics, it’s clear that Republicans’ attitudes have improved somewhat since the Nov. 5 election, but not enough to really move the needle on the overall trend.

In an environment like this, policymakers at the White House and the Federal Reserve need to do their part to calm consumers’ jitters — not add to them. Unfortunately, uncertainty may increase if President Donald Trump tries to carry out sweeping demand-boosting tax cuts and adds tariffs that should mechanically push up the price of imported goods. Defenders of Trump’s tariff gambit say the effect will amount to a one-time price-level shift, which wonks say is different from “persistent inflation.” Maybe so, but a family that has barely recovered from their last experience with supermarket sticker shock is unlikely to see it that way.

A report this week from my Bloomberg News colleagues Jenny Leonard and Saleha Mohsin tells us that the incoming economic team is “discussing slowly ramping up tariffs month by month, a gradual approach aimed at boosting negotiating leverage.” That sounds like an interesting plan to arm-twist America’s global friends and trade partners, but it also risks further damage to inflation expectations. It’s like taking the advertised one-time price level shift and breaking it down into a series of tiny chunks that look a lot like … persistent inflation! I almost feel bad for the administration economists charged with taking this bad idea (tariffs) and making it less bad (“a schedule of graduated tariffs”). Alas, that’s where we seem to be heading.

Taking a step back, the latest inflation data isn’t actually all that bad. While supply-side risks are always present, egg and gas inflation won’t last forever, and the core CPI measure — which excludes volatile food and energy — surprised economists with a 0.23% change from the previous month. With that data in hand, Bloomberg Economics now estimates that the all-important core personal consumption expenditures index, which is key for the direction of Federal Reserve policy, probably rose just 0.17% in December. If you extrapolate that pace forward, year-on-year core PCE could very well converge toward 2% in the first half of 2025. Bond traders latched onto these hopeful signals, and the yield on 2-year Treasury notes was down nine basis points at the time of writing to 4.27% on Wednesday.

In many ways, the disinflation story may still be on track for a happy ending in 2025 or 2026. But wobbly inflation expectations are emerging as a major risk to that outcome, and policymakers should do what they can to avoid shooting themselves in the foot.