Consumer sentiment edges lower in August

The U.S. consumer mood dimmed modestly in August, as the University of Michigan Consumer Sentiment Index edged lower to 69.5 from 71.6 in July. The decline reflected a somewhat diminished assessment of current economic conditions and a dimmer outlook for future conditions.

Despite the downtick, consumers remain considerably more upbeat than was the case a year ago, when inflation gauges were higher and the “most widely anticipated recession ever” was at the forefront of worries.

The index remains low by historical standards, with much room for improvement still to return to its long-term average. The August decline is a setback toward that, but a one-month, measured decline should be viewed through the lens of progress over the past year.

The fact that most measures of inflation have receded this year and are expected to continue to edge lower has been well received by consumers, although there’s still questions about the path ahead. How rapidly can inflation return to the Fed’s 2% target? Can that be accomplished without a further slowdown in the economy and loosening of labor market conditions? Is a soft landing still in the cards? Will the Fed tighten further?

To that last point, all eyes are on Fed Chair Jay Powell’s speech this morning, as investors and economists look for any insights into the current views of Fed policymakers. The recent upward pressure on long-term interest rates may suggest some reduction in investor anxiety and a walking back of the safe-haven trade spurred by earlier recession fears. It may also reflect a growing sense that perhaps the Fed isn’t done, and additional rate hikes may be coming. The latter would, ironically, increase the probability of overtightening and precipitate an even greater risk of recession.

The weakness in the survey may also reflect some additional divergence between soft and hard data on the economy. Soft data, including surveys related to business activity and consumer attitudes, have been tended to be weaker of late, while hard data has generally painted a picture of an economy has hung in better than many would have anticipated.

Even so, the full impact of Fed tightening has yet to be absorbed and is expected to further restrain economic momentum as the collective weight of higher interest rates and reduced liquidity over time. That’s the case even without additional rate hikes; further tightening would only increase the impact yet to come.

Consumers aren’t without tools to push back against higher rates though, as household balance sheets remain in a relatively good position. Debt service costs relative to discretionary personal income remains manageable, and the recovery in equity markets has bolstered retirement assets. There’s been a reduction in the stockpile of cash accumulated since 2020, but the average household still has more cash on hand than was the case coming into the pandemic. And, of course, the jobs market has come off the boil, but remains relatively robust, supporting solid wage gains.

How long the confluence of these factors can continue to drive consumer spending through the resistance of higher rates remains to be seen. Thus far, it’s been enough to at least push out a potential recession and raise hopes that a soft landing might still be a possibility.

The bottom line? The slight reduction in consumer sentiment is a modest setback in a sustained improvement in mood over the past year. The outlook is far from risk-free, but for now, the combination of sustained growth, moderate job creation, and falling inflation has given consumers hope that a near-term recession may be avoided.