U.S. consumer sentiment improves again in July

They may still be far from “all in” on the economy, but consumer anxiety continues to recede. The marked pullback in inflation in recent months has certainly been noticed, but the fact that’s been accompanied by a resurgence in the pace of growth has raised hopes that a goldilocks soft landing may still be in the cards.

The University of Michigan Index of Consumer Sentiment ticked sharply higher to 71.6 in July — a considerable surge from June’s final reading of 64.4. The index continues its grind higher after bottoming out at a historic low of 50.0 in June 2022 but is still relatively subdued compared to history.

Rising prices hit consumers hard in recent years, as purchasing power eroded despite considerable upward pressure on wages. Though inflation has eased, questions about the near-term outlook for the economy have simmered as a new potential source of worry since last year. A number of leading indicators remain solidly negative but have thus far not translated to a marked slowdown, let alone a recession.

Improvement in July was apparent in both components of the index, indicative of improvement in the consumer mood about both current economic conditions and the outlook six months out. Still, that improvement wasn’t uniform across all consumers. Lower-income households in particular remain concerned about the impact of inflation and the prospect for weaker income growth, tied directly to an expected slowdown in hiring. That’s not entirely surprising, as they haven’t benefited meaningfully from this year’s rebound in capital markets but have been disproportionately impacted by surging food and shelter costs in recent years.

With the worst of the inflation scare now in the rearview mirror, the lingering question hanging over the economy is focused on the expected path for interest rates, with the Fed recently reiterating its goal of loosening up labor markets as part of its plan to knock down inflation, as illustrated in their projection for the unemployment rate to rise around 4.5% next year.

While it’s possible that could be accomplished without a recession, a persistent, marked slowdown in the pace of job creation over an extended period seems unlikely. Once unemployment rises by a full percent, it tends to go further. While not guaranteed, a sustained increase in layoffs and unemployment has more often contributed to negative momentum that culminates in at least a mild recession. A soft landing may be possible, but history has shown how difficult that is for the Fed to engineer.

That risk isn’t lost on consumers even if it isn’t yet apparent in the hard data.

The bottom line? The sharp decline in inflation and resurgence in growth in the second quarter has raised hopes that a recession might be avoided in the near term. Consumers may still be cautious but are a bit more upbeat than they’ve been in some time. Whether that emerging optimism will be justified remains to be seen.