Consumer sentiment took a hit in May as inflation expectations rose, according to the University of Michigan Survey of Consumers. The sentiment index dropped to 67.4 from 77.2 in April, marking a one-month decline of 12.7%. This decline was driven by worries about inflation, unemployment, and interest rates moving in an unfavorable direction. Other indexes in the survey also saw substantial declines, such as the current conditions index falling to 68.8 and the expectations measure dropping to 66.5. The stock market remains strong, gas prices are slightly lower, and labor market signals are positive, yet consumer confidence has slumped significantly.
Inflation expectations also increased in the survey, with the one-year outlook rising to 3.5% and the five-year outlook climbing to 3.1%. This represents a reversal of the trend of lower readings in recent months and is concerning for policymakers. Federal Reserve officials have indicated they need greater confidence that inflation is moving sustainably back to their 2% goal before considering lowering interest rates. Expectations for an interest rate cut in September are high, but the outlook has been uncertain. Fed Chair Jerome Powell has suggested that the next move is unlikely to be a hike, but the Fed is balancing price stability and growth amidst increasing risks of stagflation.
The inflation readings from the survey have raised concerns about the impact on consumer spending in the coming months. The Fed is facing a challenge in balancing both mandates of price stability and growth, especially with rising risks of stagflation and uncertainties surrounding the upcoming presidential election. Market pricing suggests expectations for a rate cut in September, though the Fed is closely monitoring inflation trends to determine the appropriate monetary policy path. The next important data point for inflation will be the Labor Department’s consumer price index report for April, with Wall Street economists expecting a slight moderation in price pressures.
Despite positive signals in the economy such as a strong stock market rally and declining gas prices, consumer sentiment remains weak. Rising inflation expectations and concerns about unemployment and interest rates moving in an unfavorable direction have contributed to the decline in sentiment. The Federal Reserve is closely monitoring inflation trends and balancing the need for price stability and growth in deciding its next steps on monetary policy. The upcoming presidential election and risks of stagflation further complicate the economic outlook, as policymakers navigate uncertain waters in response to changing consumer sentiment and inflation expectations.
