MNI INTERVIEW: Inflation Worries Threaten U.S. Expansion–UMich

U.S. consumer spending is likely to slow down substantially as surging inflation drives worries about things like personal finances to levels consistent with past recessions, University of Michigan survey chief Joanne Hsu told MNI.

“The other times we’ve been in situations like this it’s been in the middle of a recession,” said Hsu, also a former economist at the Federal Reserve’s board of governors.

The school's consumer sentiment index plunged more than 8 points to 50.2 in May, the weakest on record, even including the height of the pandemic or the depths of the 2008 financial crisis.

“It is very likely that this will drive down spending going forward,” Hsu said. “It’s an open question how soon that shift will occur but in general when we see sentiment this low it’s during an economic contraction.”

Until recently consumers had felt relatively upbeat about personal finances, which helped explain the disconnect between falling sentiment and robust spending. “In spite of the tight labor market and strong incomes in real terms, people really are hurting,” Hsu said.

DOUBTS FED CAN CONTROL INFLATION

“In the last couple of readings we had, people were much more pessimistic about the economy than they were about their own personal finances,” she said. “This month, in this preliminary reading at least, all the components of the index are trending down.”

Surging gasoline costs and inflation more broadly are key drivers of the recent deterioration in sentiment, Hsu said, with pump prices jumping 65 cents in just the past month. "People mention gas prices spontaneously throughout the survey and it’s really weighing down on people’s attitudes,” she said.

Consumers overwhelmingly expect interest rates to rise, in line with the Fed’s messaging, but they’re still not sure that will be enough to contain the surge in prices.

“The fact that long term inflation expectations still went up in spite of that leads me to believe consumers aren’t 100% convinced that policy will be able to get inflation under control,” she said. Inflation expectations over a five-year horizon rose to 3.3% in June from 3% in May, while expectations one-year hence rose to 5.4% from 5.3%. (See MNI: Fed May Need To Raise Rates To 5% - Lacker)

“Real incomes are expected to go down and that’s another reason why sentiment around personal finances has gone down because those expected income gains are really getting eroded,” she said.