Consumer sentiment improved in February

Consumer pessimism continues to wane as inflation pressures ease, but the corrosive effects of higher prices are still being felt by American households. At the same time, there’s still a pervasive sense of caution about the outlook, with talk of recession storm clouds on the horizon. Against that mixed backdrop, the University of Michigan’s consumer sentiment index improved moderately to 66.4 in February from 64.9 in January. The Index of Consumer Expectations edged fractionally lower, but a slightly improved assessment of current conditions provided a lift.

Consumers find themselves at a crossroads. Last year’s great source of worry — inflation — is showing signs of easing, although a return to the exceptionally low inflation environment of the last decade appears highly unlikely. Looking ahead, consumers face the growing risk that inflationary worries could be replaced by a more pronounced slowdown or recession later this year. That would mean job losses — a potential reality that the Fed has indicated is likely necessary to bring inflation back to its 2% target. Lower inflation would be a welcome development for consumers, but job losses would be a painful byproduct of the Fed’s monetary policy medicine.

Over the past year, labor market conditions have been quite resilient despite the growing cracks in the foundation of the economy. Last month, unemployment dipped to its lowest level since 1969 as job creation reaccelerated. Despite a growing chorus of companies announcing layoffs, job openings remain abundant. The worry is that those could dry up quickly if layoff announcements snowball further in the coming months. Layoffs started in the tech sector but have already started to spread to other parts of the economy.

All else being equal, solid labor market conditions provide a critical support for consumer confidence and spending. This has certainly been true in the past year in the face of surging prices that have challenged consumers ability to maintain their purchasing power. The stockpile of cash that accumulated since 2020 provided the fuel, along with strong wage gains increasing consumer borrowing.

The bottom line? The consumer mood may have improved at the margins but still reflects of a consumer sector that remains cautious about what might lie ahead. Despite the surprisingly strong January jobs report, cracks are starting to emerge in the labor market. A resurgence in optimism appears unlikely in the near term, creating a practical headwind to consumer spending growth.