Expectations indices, future oriented indicators of where the economy might be headed, consumer sentiment plunged this month. The University of Michigan came in down 5%, for a new preliminary reading of 58.6. If the index does drop this will be the first erosion in consumer confidence since a slight uptick from abysmal, though still near-record lows, in early summer. Here’s what’s driving this drop in optimism. Rising inflation expectations and the knock-on effects from President Donald Trump’s trade policies are major factors.
Even with this downturn in sentiment, economic experts say that American consumers will still be spending. In addition, historical trends show that what consumers say they feel does not always match how they act — or even what they expect. Therefore, even as confidence diminishes, spending may continue to be strong, playing a large role in driving economic output.
Factors Influencing Consumer Sentiment
The recent decline in consumer sentiment can be explained by deteriorating economic conditions and external headwinds. Longer-term inflation expectations have increased, reaching 4.9% this month, up from 4.5% in July. This increase is a clear indication that concerns about price stability are rising in the face of an uncertain economic recovery. In addition, analysts point out that consumer sentiment is still well below where it was at the end of last year, right after the presidential election.
Joanne Hsu, a leading economist at the University of Michigan, highlighted the broader implications of these sentiments:
“However, consumers continue to expect both inflation and unemployment to deteriorate in the future.”
Consumer sentiment has had a tough time forecasting future spending in recent years. Despite its many shortcomings, it continues to hold economists and policymakers in thrall. The relationship between sentiment and real spending is not that straightforward. Most notably, the nature of this relationship shifts with employment rates and general economic conditions.
Historical Context of Consumer Spending
In our recent analysis of consumer revealed preference data, we found a surprising and foretelling trend. After all, sentiment doesn’t necessarily dictate spending behavior. This past year, consumer optimism fell to historic lows as inflation reached a 40-year high. Americans were seemingly undeterred by a growing economic storm, and the spending spree persisted. Just like that, despite congress’s 2023 debt ceiling standoff—which took a toll on consumer confidence—consumers continued to spend.
Recent economic conditions, such as an unemployment rate of only 4.2%, help soften the blow on consumer spending. As Chris Zaccarelli noted:
“As long as consumer spending holds up and companies are able to retain workers because of that robust spending, the flywheel can continue to spin, pushing corporate profits and stock prices higher.”
Retail sales data supports this assertion. With consumer prices climbing at just 0.2% a month, that still meant a healthy 0.3% jump in sales last month after adjusting for inflation.
The Role of Consumer Behavior in Economic Output
Consumer spending is the biggest driver of economic growth in the United States—about 70 percent—so it is the key to that growth. Richmond Fed economists have heard from businesses about how the increased costs from tariffs are affecting their planned price changes. That said, it will take time for any changes, small or large, to manifest in significantly different results.
Bill Adams, an economist at an investment firm, emphasized the discrepancy between what consumers say and how they act:
“What consumers do is more important to the economy than what they say.”
This perspective suggests that consumer actions may outweigh their expressed sentiments, leading to continued economic activity despite declining confidence levels.