The consumer outlook dimmed in May as growing cracks in the foundation of the labor market and the realization that interest rates may remain higher for longer weighed on the collective mood.
The University of Michigan Consumer Sentiment Index dropped from 77.2 in April to 69.1 in the latest reading — a surprisingly sharp decline over a single month. Even so, economists had been braced for an larger drop, given the even greater decline in the preliminary May reading. The decline brought the index to its lowest point in five months.
Both components of the index declined sharply, as consumers reassessed their view of both the current state of the economy and their expectations for the coming year.
Labor conditions are understandably a key driver of consumer sentiment — one that has been a key pillar under both consumer confidence and consumption in recent years. Robust labor demand and strong job creation has provided ample opportunities for workers to find a job or trade up to a better-paying one. Given the competitive market for workers, robust wage growth has provided fuel for the spending fire since late 2020.
More recently, wage growth has eased as the economy has come off the boil and the number of job openings has reverted toward pre-pandemic norms. Lower wage growth, coupled with indications that a growing number of households have exhausted their savings stockpile, will undoubtedly dim the enthusiasm of consumers and weigh on household spending growth.
Beyond the labor economy, which has cooled but is far from worrisome, inflation remains the predominant concern for consumers. Having lived through the worst of the inflation surge in recent years, expectations have been reined in considerably, but few expect that a return to the pre-pandemic 2% inflation norm is likely in the near term.
Inflation expectations edged fractionally higher from 3.2% in April to 3.3% in May, indicative of a lingering concern that price pressures could remain problematic over the coming year, if not find a second wind.
The silver lining is that the final May expectations number was better than the 3.5% preliminary estimate released earlier this month. Regardless, consumers clearly don’t anticipate an immediate return to the Fed’s 2% inflation target. That calls into question how soon the Fed might be willing and able to trim their short-term policy rate and how aggressively policymakers may cut once that easing cycle begins.
The surge in short-term rates have rippled through to mortgages and consumer credit, raising the cost of carrying credit card debt and significantly curtailing home sales — evidence that the Fed’s tightening of rate policy in recent years is having the desired effect by cooling growth.
The bottom line? Consumers remain skeptical on the inflation outlook but are increasingly aware of cooling labor market conditions and slower wage growth. Will they continue to spend or begin to retrench in anticipation of tougher sledding ahead? That’s the unanswered question. If May’s sentiment index provides any indication of the near-term direction, a more pessimistic consumer is likely to tighten their proverbial purse strings a bit in the coming months.
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