Consumer sentiment fell in March, before the financial turmoil

  Consumer sentiment in March dropped to 63.4 from 67 as consumers’ confidence in the current economic conditions and their expectations both worsened on the month, according to the University of Michigan’s survey released Friday. The decline in sentiment, though, was not influenced by the recent turmoil in the banking system, the University of Michigan noted in its preliminary report. The final report, which comes out in the last week of the month, will most likely show more deterioration in sentiment. On a three- to six-month horizon, sentiment bounced off the record low of 50 set in June, yet remained significantly lower than the pre-pandemic level of 90 to 100. The preliminary results signaled a slowdown in spending intentions as all spending subindexes from autos to houses retreated on the month. There are, however, clear reasons not to overinterpret the one month of data because sentiment and actual spending have been quite disconnected since the start of the pandemic. Consumers often do not stop spending when they expect a slowdown. They stop spending only when they have to—for example, when their future income stream and jobs are in danger. That is why spending historically does not drop before a recession or even at the beginning of one. Consumer spending declines only in the middle of a recession when the unemployment rate spikes. We expect spending to hold up even if sentiment continues to worsen before a recession, which we forecast to take place in the second half of the year.

Inflation expectations

One bright spot from the report came from the decline in inflation expectations, which showed the biggest drop in months. Inflation expectations for 12 months in the future fell to 3.8% from 4.1%, while the long-term, five- to 10-year expectation fell to 2.8% from 2.9%. The overall declines in expectations are quite surprising given the rebound in inflation in recent months. One reason might be the impact of lower gasoline prices. But for whatever reason, the decline in inflation expectations is welcome as the Federal Reserve tries to balance multiple goals, which now include maintaining stability in the financial system.

The takeaway

With the Fed set to meet next week, all the data is pointing toward a 25 basis-point hike, which would represent a middle course between the 50 basis-point increase that had been expected before the bank failures and a pause that some are calling for. When the Fed’s credibility and the effectiveness of its forward guidance are at risk, a 25 basis-point hike seems to be the least risky decision.