The Federal Reserve's "heightened sensitivity" to rising inflation expectations could be triggered by a barrage of political ad campaigns that are expected to highlight surging consumer prices ahead of the midterm elections in November, analysts at Goldman Sachs warned on Friday, adding that the central bank may feel "compelled" to keep hiking rates aggressively.
With the midterm elections looming in November, surging consumer prices will be a major issue for voters—especially as long-term inflation expectations have surged in recent months, according to the latest consumer sentiment survey released by the University of Michigan on Friday.
Meanwhile, the Federal Reserve watches long-term inflation expectations closely, and used it in its decision earlier this month to raise interest rates by 75 basis points—the largest increase since 1994.
The central bank's "strong reaction" to the data demonstrates a "heightened sensitivity to any further upward drift in inflation expectations," with the Fed likely to try and moderate any further increases, analysts at Goldman Sachs said in a recent note.
What's more, with high inflation top of mind for voters, it is likely to feature prominently in political advertisements ahead of the midterm elections—and inflation expectations "have historically been quite sensitive to political outcomes," the analysts wrote.
Political campaign ads highlighting surging consumer prices will likely to "help shape" inflation expectations and drive them higher for the rest of 2022, the firm predicts, noting that polling data suggests Republicans intend to portray inflation as a "major vulnerability" for Democrats.
The "coming barrage of political advertisements" could result in Fed officials feeling "compelled to respond forcefully" to moderate rising long-term inflation expectations by raising rates more aggressively, Goldman analysts said.
"The upcoming political cycle will therefore likely keep inflation top of mind, and consumers might respond to these campaign messages by revising inflation expectations higher," according to Goldman analysts. "As a result, we see the upcoming onslaught of inflation-focused political advertisements as adding to the risk that the Fed could continue to tighten aggressively even if economic activity decelerates sharply."
What To Watch For:
With U.S gas spiking to nearly $5 per gallon in recent months, the rising prices have been a "main driver" behind the rise of inflation expectations, Goldman analysts said. The firm predicts more increases in food and gas prices ahead, particularly if oil prices surge higher, both of which could further dent consumer sentiment.
The stock market is having a dismal 2022 amid surging inflation and rising interest rates, with the benchmark S&P 500 falling more than 20% from its record highs into bear market territory. Looming midterm elections in November—with Republicans hoping to win back control of either the House of Representatives or the Senate—will add yet more uncertainty to the mix. Historically, the best outcome for markets has always been under a Democratic president kept in check by a split or fully Republican Congress, according to an analysis by Forbes earlier this year. The S&P 500 rose by an average of 13.6% when a Democratic president presided over a split Congress, while a Democratic president working with a unified Republican Congress saw a 13% average gain.
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