Households Shrugged. Wall Street Didn't.

• NY Fed one-year inflation expectations held steady at 3.6% in August.

• Three-year expectations ticked down to 3.2% from 3.3%.

• Both gauges sit close to their historical norms, meaning households are wary of inflation, not alarmed by it.

Inflation is the rearview mirror. Expectations are the windshield…

As I noted yesterday, the latest inflation data from the U.S. Bureau of Labor Statistics shows price growth has been fairly tame outside of the spike we experienced from March through April. That’s the fundamental backdrop heading into tomorrow’s monetary policy announcement from the Federal Reserve. And the New York Fed’s latest consumer survey backs it up. Because households aren’t bracing for another leg higher in prices…

Most of the debate lately hasn’t been about whether inflation is spiraling — it’s been about whether the bond market has already made the call for our central bank. The Chicago Mercantile Exchange’s FedWatch tool shows bond market speculators have moved hard toward pricing in a rate increase. That’s the kind of setup where a central bank either delivers or risks looking like it’s fallen behind its own guidance. But a market repricing isn’t the same thing as an inflation problem. And that distinction matters for how investors should read the outcome.

You see, the Federal Reserve worries about inflation expectations…

• Policymakers know sentiment can quickly become reality.

• When consumers think prices will keep rising, they change behavior now.

• They buy goods ahead of time and stockpile.

Future demand gets pulled forward into the present. And if inventories plummet, the upward price pressures increase. Once that happens, our central bank must act.

The latest New York Fed survey shows expectations remain broadly anchored. Near-term views held their ground, and longer-term expectations ticked lower. In fact, they continue to hover right around their historical averages. That’s the tension heading into today’s decision: the inflation data doesn’t demand a hike, even if the market has already priced one in. So, unless we’re on the front end of rapid rate hike cycle, which seems highly unlikely, the current setup should support a steady rally in the S&P 500 Index.

But don’t take my word for it, let’s look at what the data’s telling us…

The New York Fed recently released its Survey of Consumer Expectations for August. It summarizes responses from 1,300 households on inflation, household finances, and the labor and housing markets. The survey rotates participants to keep the sample fresh.

This survey gives policymakers a window into how people think and how they’re likely to behave. These readings matter because they show whether households expect inflation to keep climbing or drift back toward normal. Based on the latest results, near-term expectations held steady…

• 12-month inflation expectations held at 3.6% in August, matching July and down from June’s 3.7%.

• The long-run average since 2013 is just above 3.3%.

• The gauge remains well below the 6.8% peak struck in 2022, when the Fed’s hike cycle began.

The longer-term picture tells the same story…

• Three-year inflation expectations eased to 3.2% in August from 3.3% in July.

• The survey’s historical norm is right around 3%.

• The latest data is also consistent with pre-pandemic levels.

Move out to five years, and the pattern holds…

• Expectations held at 3% for a twelfth straight month.

• That’s just above the longer-term average of 2.8%.

• This isn’t runaway inflation data.

As I noted at the start, the Fed pays close attention to these numbers. Policymakers want to know how much support they can or can’t introduce for the economy without reigniting the long-term inflation surge we saw in 2021. We’ve had a few bumps, but nothing that resembles a repeat episode, at least not according to the NY Fed’s latest read.

That’s exactly why tomorrow’s decision is worth splitting into two stories. One is about inflation, and on that score, the data says the Fed has room to be patient. The other is about market pressure, and on that score, the Fed’s hand looks increasingly forced.

Fed Chair Kevin Warsh has signaled composure on the inflation backdrop specifically. The data above backs that up. But composure on inflation doesn’t mean the Fed can ignore how far rates markets have already moved to price in tightening. Patience has a shelf life, and it may be expiring this week — not because the fundamentals broke, but because the market forced the issue.

That’s the real takeaway heading into tomorrow’s monetary policy decision. If our central bank raises rates, it’s most likely doing so because rates Wall Street left policymakers little room to do otherwise. It’s not because the underlying inflation story deteriorated materially. And if this week ends up looking more like one-and-done than the start of a new hiking cycle, stocks should be able to digest it.

Five Stories Moving the Market:

Microsoft has published a provisional code of conduct that it aims to apply when training new artificial-intelligence models, the latest company to discuss limits on advanced AI systems as OpenAI’s chief executive warned companies risk losing control of their AI systems – WSJ. (Why you should care – Microsoft’s AI chief said the company has been working on the guidelines for months, which it calls “humanist AI”)

Benchmark 10-year U.S. Treasury yields climbed above 5%, the highest level since October ​2023 and a closely watched psychological threshold that analysts say ‌could ripple through the U.S. economy – Reuters. (Why you should care – higher borrowing costs are likely doing the Federal Reserve’s job for it, without having to raise interest rates)

Prime Minister Mark Carney said the dramatic collapse of trade talks with the U.S. in August helped clarify Canada’s negotiating “red lines,” while adding he’s ready to get back to the table for the right deal – Bloomberg. (Why you should care – the statement comes on the heels of Trump’s comments that the two sides should strike a deal “soon”)

European Central Bank President Christine Lagarde said Europe must become a producer of artificial intelligence technology, partly to preserve its own autonomy and achieve the efficiency gains needed to maintain its way of ​living – Reuters. (Why you should care – Lagarde is concerned that falling behind in the AI data center race will leave Europe more beholden to foreign entities, hurting its economy and independence)

Bank of America Chief Executive Officer Brian Moynihan said trading revenue will be “relatively flat” compared with last year’s third quarter, an unexpected break from the surge that Wall Street saw in the first half – Bloomberg. (Why you should care – the slowdown appears to be company specific as Citigroup said its capital markets business should be in-line with expectations)

Economic Calendar:

U.K. - Labour Market Report for July (2 a.m.)

U.S. - NY Empire State Manufacturing Index for September (8:30 a.m.)

Treasury Auctions $75 Billion in 6-Week Bills (11:30 a.m.)

ECB's Schnabel (Executive Board) Speaks (1 p.m.)

Treasury Auctions $13 Billion in 20-Year Bonds (1 p.m.)

U.S. - American Petroleum Institute Crude Oil Inventory Data (4:30 p.m.)