Consumer sentiment took a hit in May as inflation expectations rose, leading to concerns about negative developments in the economy. The University of Michigan Survey of Consumers reported a significant decline in sentiment, with the sentiment index dropping to 67.4 from 77.2 in April. This marked a one-month decline of 12.7%, although there was a year-over-year gain of 14.2%. Inflation expectations for the one- and five-year horizons also increased, with the one-year outlook reaching its highest level since November 2023.
The downbeat sentiment was accompanied by declines in other indexes in the survey, including the current conditions index and the expectations measure. Despite positive signals in the economy such as a strong stock market rally and slightly lower gasoline prices, consumer worries about inflation, unemployment, and interest rates weighed on sentiment. Jobless claims also hit their highest level since August 2023, adding to concerns about the labor market.
The inflation readings are a key concern for policymakers, particularly the Federal Reserve, as they consider the near-term path of monetary policy. Uncertainty about the inflation path could impact consumer spending in the coming months, complicating the Fed’s dual mandate of price stability and growth. The Fed has indicated that they need “greater confidence” in inflation moving sustainably back to their 2% goal before considering lowering interest rates.
Market pricing suggests expectations that the Fed will begin reducing its key borrowing rate in September, after holding it at its highest level in over 20 years since July 2023. However, there is uncertainty about the Fed’s next move, with Fed Chair Jerome Powell indicating that a rate hike is unlikely. The upcoming consumer price index report for April will provide important data on inflation, with most economists expecting to see a slight moderation in price pressures even as the CPI index has been running above the Fed’s target.
Overall, the decline in consumer sentiment despite strong economic indicators highlights the impact of rising inflation expectations on consumer perceptions. Policymakers are facing challenges in balancing price stability and growth amid concerns about inflation, unemployment, and interest rates. The upcoming months will be crucial for the Fed as they weigh the need for further monetary policy actions to address the evolving economic landscape.
