Inflation Kneecaps Sentiment As Faith In Policies Crumbles

Consumer sentiment deteriorated in early January as inflation worries proliferated and Omicron cases surged.

The preliminary read on University of Michigan’s gauge for this month was 68.8, below consensus and the second lowest print in a decade (figure below).

“The Sentiment Index has averaged just 70.3 in the past six months, whereas in the first six months of 2021 it averaged 82.9,” survey chief economist Richard Curtin said Friday.

Both the expectations and current conditions gauges fell.

75% of consumers said inflation was a more serious concern than unemployment, an opinion the Fed now shares.

Notably, the “K-shaped” inflation dynamic made a cameo. “Given that inflation’s impact is regressive, the Sentiment Index fell by 9.4% among households with total incomes below $100,000 in early January, but rose by 5.7% among households with incomes over that amount,” Curtin observed.

As detailed extensively in “The Tragedy Of Inflation Inequality,” the more money you make, the less you spend (as a percentage) on food, energy, shelter and other things for which prices have risen the most (figure below).

The same disparity was evident in overall perceptions of the economy in the Michigan survey. Lower-income households had a more negative outlook than higher-income families.

But Curtin suggested “optimistic” is a relative term. Even those inclined to a glass half-full assessment disproportionately expected unfavorable economic developments going forward, he said.

Consistent with my (ad nauseam) contention that the White House has a vexing PR problem which is rapidly morphing into a crisis of confidence, Curtin noted that consumers’ faith in government economic policies is at its lowest level since 2014 (figure below).

To reiterate: Inflation is, in part anyway, a psychological phenomenon. So, it’s extremely important that the messaging is effective. Short circuiting the expectations channel is key when it comes to preventing inflation from becoming entrenched.

Inflation expectations in the Michigan poll rose. The expected change in median prices during the next year ticked up to 4.9% from 4.8%, while the expected change over the next 5-10 years rose to 3.1%.

The figure (below) is disconcerting. “The importance of inflation in determining future financial prospects was dominated by how consumers judged their future inflation-adjusted incomes,” Curtin remarked, summing things up.

A look at the more granular breakdown showed just 17% of consumers expect real income gains this year.

The somewhat dour read on sentiment in early January came just hours after the market frowned at an extremely poor retail sales report, which suggested consumers retrenched meaningfully in December.

With the social spending plan in limbo and the Fed poised to aggressively tighten policy, you’d be forgiven for questioning the viability of rosy growth forecasts. Or at least for the US economy.