In early December, American consumer confidence was at the highest level since the Great Recession. The Consumer Sentiment Index increased to 53.3, an increase over 51 in November. The jump was larger than economists had predicted. It underscores a growing positivity among families towards their immediate impact and the future state of the economy. While this was welcome news from an employment perspective, the opposite was true when looking at inflation and the strength of the US Dollar.
Looking at the US Dollar, it has really been getting crushed recently. Consequently, the US Dollar Index (DXY) has slid to multi-week lows, dipping below 99.00. This drop is indicative of persistent headwinds from inflation and interest rate expectations. Economists like to say core inflation is what central banks care about. It has a mandate that plays a critical role in coalescing the public and shaping monetary policy.
Inflation Trends and Interest Rate Implications
This is why core inflation is usually the go-to measure for economists and central banks alike to focus on. This measure removes volatile components such as food and energy. When the core Consumer Price Index (CPI) exceeds 2%, it generally ignites speculation about an impending rise in interest rates. On the flip side, when it goes below 2% folks tend to expect interest rates to go down. The short-term, one-year inflation expectations just slipped to 4.1% from 4.5%. At the same time, their five-year forecast decreased, sinking to 3.2% from 3.4%.
The Federal Reserve and other central banks would like to keep inflation close to 2% so economic growth can continue without triggering rising prices. As these indicators continue to be bumpy, the markets are always on the lookout for the next sign that monetary policy is turning. Indeed, core inflation figures have recently taken a turn for the better. That would likely force the beleaguered central bank to reconsider its permissive baseline forecast for interest rates.
Consumer Sentiment and Current Conditions
The Consumer Sentiment Index’s increase represents a sign that American households are beginning to feel more optimistic about their economic prospects. By comparison, the Current Conditions index fell, biting the bullet to drop to 50.7 from 51.1. However, there is a general pessimism about the new expected normal after the pandemic, with a fundamental reshaping of economic fundamentals. The Consumer Expectations index increased from 51 to 55, offsetting those worries.
This split highlights that even though consumers have plenty to be concerned about today, they are starting to be more optimistic about what is to come. Taken together, this indicates that consumers are lowering their expectations in response to a changing economic landscape and possible waves of policy change.
Broader Economic Outlook
Given these conflicting signals, analysts will undoubtedly be keeping an eye on consumer sentiment and inflation trends in the weeks to come. Inflation, as it usually appears in the news, is a bit misleading. Headline inflation is usually reported as a month MoM and year YoY percentage change. New data shows recent reversals that could shape future economic policies.
At the same time, producers and especially consumers are becoming more optimistic and confident. Policymakers will need to navigate this economic growth against the backdrop of continued strong and effective inflation fighting. Nothing is ever static when it comes to current economic indicators. They will have a profound effect on consumers and businesses alike.