Issue 86: Waning Consumer Confidence

This Week’s Highlights

• Consumer confidence showing cracks
  Last Friday’s release of the University of Michigan’s final survey of consumer sentiment for May showed Americans feeling worse about the state of the US economy, with high interest rates, budget-breaking inflation, and labor market risks weighing heavily on households’ psyches.
• FOMC minutes reveal talk of more hikes
  Earlier last week, the Fed released a transcript of discussions at the bank’s April–May meeting, which showed officials expressing frustration over stalling disinflation in Q1, musing on whether conditions are tight enough, and even broaching the possibility of another leg up in rates.
• BoE rate cut looking unlikely in June
  Though UK CPI fell in April to just within reach of the BoE’s 2% target, it represented a positive surprise and showed services prices still running too hot for policymakers to begin cuts in June. That’s bad news for the UK’s incumbent Tory party, with a snap election on tap for July.

The CIO’s Take:

• We spend a lot of time looking at data on what’s actually happening in the US economy, but it’s worth continually checking in on how Americans feel about things. Along those lines, weakening sentiment could be a sign households are hitting their financial wits’ end—in our view, yet another downside risk to spending and growth.
• With traders still pricing 1–2 cuts by the Fed before year-end, we also see somewhat greater risk of a negative surprise in the case of Fed policy, as a readout of discussions at last month’s FOMC showed strong consensus that it’s not yet time to cut, and even some calling for the bank to get more restrictive amidst hard-to-tame US inflation.
• Even in the UK, where CPI seems much closer to that comfortable 2% level, policymakers looking at pressure on services prices feel far too anxious to ease. That’s a bigger problem across the pond, given weaker growth and political uncertainty—which leads us to take a more selective, bargain-hunting approach to investing in UK stocks.

Waning Consumer Confidence

Sentiment sags in U. Michigan survey
We often talk in Perspectives about the macroeconomy from the standpoint (we hope!) of an objective, dispassionate investor. But how do things feel to the average American? According to the University of Michigan, US consumer sentiment has seen better days. According to the school’s final May reading of consumer confidence, the well-known measure took a big hit in May, falling 10% from its April level to establish a new half-year low after treading water the last few months.

Confidence low versus historical data
While US consumer confidence was an impressive 40% above an all-time low reached in June 2022 and nearly 20% higher than it was just a year ago, those are relatively low bars: these levels sit comfortably within the bottom fifth of historical readings since the survey started in 1978. Survey director Joanne Hsu pointed to evidence in polling that consumers were especially worried about wage growth stalling and unemployment creeping up, along with high interest rates stemming from more intransigent inflation—all very reasonable concerns, and risks we’ve discussed.

Americans see the glass as half-empty
At the same time, we have generally found our anxieties over some of these macro downsides tempered by a recognition that the US economy is in better shape than we might have expected it would be, given where we are in the cycle. Interestingly, most Americans apparently seem convinced conditions are already much, much worse. Indeed, according to a poll conducted by Harris on behalf of the Guardian in mid-May, some of consumers’ beliefs about the state of affairs are surprisingly dismal (see below)
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Polling contradicts facts on the ground
The reality is robust growth, unemployment near a 50-year low, inflation which—although stickier than we would like—is way off its 2022 highs and trending down, along with a booming S&P 500 Index year-to-date. That a large percentage of everyday Americans perceive the US as already in a recession, unemployment as too high, inflation as climbing, and the stock market as tanking? This seems to us a sign that the will of consumers, struggling with their personal finances against a backdrop of high prices, high rates, and meaningful debt, might finally be buckling under the pressure.

Bleak perceptions underscore risk
Insofar as relentless spending by the American consumer has been driving growth and helping US companies to keep profits up, seeing households lose confidence could mark a turning point in the economic strength some investors likely take for granted. Incumbent President Biden will also take note of these results as a risk to his reelection. While it’s true that Republicans are much more likely to blame his policies for making the economy worse—70% of respondents in the Harris/Guardian poll—an alarming 39% of Democrats agreed with that sentiment.

Parsing FOMC Minutes

No action at Fed meeting, but plenty of talk
With the April–May FOMC meeting resulting in a sixth consecutive hold on high rates, it would be easy for investors to conclude ‘nothing to see here’ and tune the Fed out until later this summer. At its next meeting in mid-June, futures currently point to over a 99% chance the US central bank skips again. Of course, for news junkies like us, there’s plenty to process in between meetings, regardless of whether they result in actual policy moves. Since last Wednesday’s release of the April–May FOMC meeting minutes, we’ve been thinking about what they mean for an eventual pivot.

Disinflation disappointment in Q1
One theme in the transcript of last month’s deliberations that’s hard to ignore: Fed officials sound increasingly worried about price pressures disrupting disinflation since the beginning of this year. Members of the policymaking committee referred to CPI prints in the first quarter as “disappointing” and “assessed that it would take longer than previously anticipated for them to gain greater confidence that inflation was moving sustainably toward 2%”, the Fed’s inflation target.

Fed officials worry about weak sentiment
Economists at the central bank also discussed the flagging consumer confidence we just covered, expressing similar concerns, noting that “the finances of low- and moderate-income households were increasingly coming under pressure, which these participants saw as a downside risk to the outlook for consumption.” There were also references in the discussion to credit card debt and buy-now-pay-later financing, both of which we have often noted as illustrating the strain facing consumers as rates remain high while inflation fails to succumb.

FOMC wouldn’t rule out rising rates
That brings us to another notable thread in the FOMC’s April–May conversation: according to Fed officials, rates could still go higher. Language present in the prior meeting’s minutes indicating rates had likely peaked was absent from this transcript. Instead “participants mentioned a willingness to tighten policy further should risks to inflation materialize”. Looking at the Chicago Fed’s measure of national financial conditions, which were already loosening since early 2023 (see below), it’s easy to see why members of the committee might question whether policy is restrictive enough.

One needn’t look far for “risks to inflation”, after a quarter’s worth of hotter-than-expected prints. Even April’s softer read wasn’t up to every Fed official’s standards, with governor Chris Waller telling an audience at the Peterson Institute for International Economics in Washington last Tuesday that April CPI gets a “C+” grade and doesn’t move the needle much on cuts, which he suggest could come only after “several” months of better progress. Such thinking brings folks at the Fed more in line with our long-held view that rate cuts are highly unlikely until closer to Q4, at the earliest.

UK Policy Outlook

CPI trend belies April upside surprise
Unlike in the United States, where the first quarter brought an unwelcome rebound in inflationary pressure, conditions across the pond look to have been steadily improving since year-over-year CPI peaked in October 2022 at a staggering 11.1%, two points higher than where rates topped out on the United States. The UK’s Office for National Statistics last Wednesday reported that April CPI fell from 3.2% to 2.3%, its lowest in three years. Unfortunately, that was a hotter reading than analysts and the bank were expecting, as services CPI was still running at 5.9% year-over-year (see below).
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More concerns with UK disinflation
That hot print sent the pound to a two-month high against the dollar and all but dashed previous hopes the Bank of England (BoE) could begin cutting rates in June, as traders inferred stickier prices ahead. The stats get even more concerning when one digs a little deeper, as the plummeting headline number in April largely resulted from lower energy prices after UK regulators cut household tariffs. Moreover, in contrast to the United States, where growth remains strong, the longer-term downtrend in UK CPI has come from stagnant domestic consumption: hardly a cheerful source of disinflation.

Snap UK election looming in July
There is a political dimension, as well, with embattled UK Prime Minister Rishi Sunak surprising the market last Wednesday—the same day as the CPI release—with an announcement of a snap general election on July 4th. Elections had to be held before December, and most expected Sunak to wait for a vote under better economic conditions. With weak public finances and now little hope for inflation to markedly improve, we imagine the PM feels better taking his chances that things could get worse. That’s saying something, as the opposition Labour party presently polls 20 points ahead.

BoE unlikely to cut ahead of vote
Much as we suspect the Fed considers November elections in its timing of a pivot to easing, it seems likely to us the BoE will be in no rush to cut rates before July and risk appearing to support the Tories ahead of a July vote. Given the apparent trajectory of prices and weak domestic demand, we see August as the most likely start to easing in the United Kingdom. Of course, all eyes will be on the Office of National Statistics’ May CPI, with anything but a big downside surprise confirming April’s read can’t be chalked up to an Easter effect, and reinforcing that the United Kingdom, too, faces sticky prices.