Quantitative strategy

How well anchored are US inflation expectations?

07 February 2022

By Lukas Gehrig, Zurich Switzerland, Quantitative Strategist; Nikola Vasiljevic, Zurich, Switzerland, Head of Quantitative Strategy

Steering and anchoring inflation expectations through forward guidance has been the name of the game for central banks since the 1990s. Recent surveys for US inflation expectations suggest that anchors that have held for 20 years may be nudging up. However, quantitative analysis suggests that this shift is too small, so far, to be worrisome for financial markets.

You’ll find a short briefing below. To read the full article, please select the ‘full article’ tab.

  • Summary
    • The US Federal Reserve has used forward guidance about the path of future interest rates as one of its primary tools to affect economic outcomes since the 1990s
    • But surges in inflation expectations since the onset of the COVID-19 pandemic suggest that long-term expectations may have become de-anchored from the central bank target range
    • However, our analysis shows that the anchors remain largely in place. This weakening of the anchors is likely to do with the Fed’s bulging balance sheet
    • This ballooning of inflation expectations is unlikely to cause the Fed to rush interest rate rises – the phenomenon is also occurring in the eurozone and the UK, but on a less dramatic scale than in America
  • Full article

    Inflation expectations in financial markets rely heavily on central bank statements. In the US, this success-story for policymakers started in 1994, when the Federal Open Market Committee first issued statements on monetary policy decisions. From 2000, it also provided a risk assessment for the economy, indirectly guiding markets expectations for the likely path of rate moves. Around that time, long-term consumer price index expectations became firmly anchored (see chart).

    Recent surges in anticipated five-year inflation from professional forecasters give rise to questions regarding the strength of inflation anchoring of late, and possible consequences of a weaker anchor.

    Professional forecasters, consumers, and market participants

    There is no one measure for anticipated inflation. Depending on whom you survey (or measure), the answer differs. Survey responses from consumers have historically been up to one percentage point above those of professionals, which makes the recent surge in expectations look even more dramatic. Market-implied data reflect not only “pure” inflation expectations, but also demand for external factors, such as hedging for pension fund portfolios.

    All these measures have experienced a recent surge and in the case of the five-year measure, this surge reached highs unseen since the turn of the millennium. The dispersion of forecasts by professionals – measured by the distance between the 25th and 75th percentile – is as high as it was during the global financial crisis. Meanwhile, 10-year expectations have merely been brought back to their pre-global financial crisis measures (see chart).

    Testing the anchors

    Surveys of inflation expectations suggest that long-term anchors have nudged a little, but not left the ground. Meanwhile, uncertainty around the US inflation rate in five years’ time has grown considerably.

    To test the strength of the anchoring, our regression model seeks to explain the quarterly change in professional survey expectations, by surprises against past expectations, while controlling for the economic cycle.

    The chart shows estimates of anchoring coefficients from three-year rolling regressions. A high and statistically significant estimate for the anchoring coefficient indicates that forecasters are revising their long-term inflation expectations based on the latest inflation rates.

    chart: inflation expectations anchoring coefficients and probabilit (p)-values for five-year and ten-year

    Moderate weakening in anchors started before 2021

    As indicated by the high p-values and low coefficients, inflation expectations were very firmly anchored between 1994 and 2012 before dipping, then reaffirmed in 2015 before weakening again by surprise prints in 2018.

    The recent weakening compares to estimates seen in the move started in 2018, when expectations fell by 30 basis points. Though inflation surprises were much more extreme in size, the subsequent recalibration of expectations was proportional.

    One likely reason for the gradual weakening of anchors since 2012 lies in the US Federal Reserve’s (Fed) balance sheet, which has become another variable for inflation considerations. Given its expansion to gargantuan size since the financial crisis, anchors may be recalibrated more frequently as the balance sheet shrinks.

    Anchors dragging back and forth

    On the basis of the proportional reaction of expectations up to surveys taken in the November 2021 for the fourth quarter, and our own view of inflation receding to more manageable levels towards the end of the year, the Fed should not need to rush rate rises. However, CPI continued to surprise to the upside, which may have added dynamic to the de-anchoring process.

    A significant de-anchoring of expectations could lead to vastly different outcomes, depending on the stance the policymakers take. The central bank could reinforce the anchor with rigorous interventions. Alternatively, it may let inflation expectations, and realisations, spiral up before stepping on the monetary brakes. 

    It seems unlikely that the Fed will stand by and watch inflation get too out of hand. While many market participants, including the US Treasury, could profit from higher inflation, the prospect of runaway inflation that requires more abrupt stopping seems very unattractive.

    US phenomenon only?

    So far, our focus has been on US inflation expectations. Surveys for long-term inflation expectations by the European Central Bank also show an upward shift in forecasts. For the eurozone, however, long-term expectations used to be anchored around 1.9%, then fell in 2019, before only returning to the old anchor value with the recent recalibration seen in many countries. For the UK, survey-based measures of inflation expectations by forecasters have risen, but not as dramatically as seen in America.

    While some cost-push factors are global, the context in which these inflation surprises have come in is not. We have argued before that the US is leading this economic recovery, in part due to the aggressiveness of the monetary and fiscal stimulus in the pandemic. Growth tends to be slower in other developed markets. Therefore, domestic drivers of inflation are, like the recovery, building up more gradually.

Related articles


Market Perspectives March 2022

Welcome to the March edition of "Market Perspectives", the monthly investment strategy update from Barclays Private Bank. In this month’s report, we look at just how likely a recession might be, and what it could mean for equities, bonds, and other asset classes.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This communication:

  • Has been prepared by Barclays Private Bank and is provided for information purposes only
  • Is not research nor a product of the Barclays Research department. Any views expressed in this communication may differ from those of the Barclays Research department
  • All opinions and estimates are given as of the date of this communication and are subject to change. Barclays Private Bank is not obliged to inform recipients of this communication of any change to such opinions or estimates
  • Is general in nature and does not take into account any specific investment objectives, financial situation or particular needs of any particular person
  • Does not constitute an offer, an invitation or a recommendation to enter into any product or service and does not constitute investment advice, solicitation to buy or sell securities and/or a personal recommendation.  Any entry into any product or service requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding documents
  • Is confidential and is for the benefit of the recipient. No part of it may be reproduced, distributed or transmitted without the prior written permission of Barclays Private Bank
  • Has not been reviewed or approved by any regulatory authority.

Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.

Barclays is a full service bank.  In the normal course of offering products and services, Barclays may act in several capacities and simultaneously, giving rise to potential conflicts of interest which may impact the performance of the products.

Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.

Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation. Law or regulation in certain countries may restrict the manner of distribution of this communication and the availability of the products and services, and persons who come into possession of this publication are required to inform themselves of and observe such restrictions.

You have sole responsibility for the management of your tax and legal affairs including making any applicable filings and payments and complying with any applicable laws and regulations. We have not and will not provide you with tax or legal advice and recommend that you obtain independent tax and legal advice tailored to your individual circumstances.