Curtin’s Warning: Americans May ‘Misinterpret’ Fed Hikes

There was no improvement in US consumer sentiment during the back half of January. In fact, sentiment deteriorated further.

That was the overarching message from the final read on the University of Michigan’s gauge for this month. At 67.2, the headline index dropped from the preliminary print, touching a new decade low in the process (figure below).

The range, from nearly four-dozen economists, was 67 to 70. So, the actual print very nearly matched the most pessimistic guess.

Notably, there’s not much in the way of disagreement between Democrats and Republicans when it comes to whether inflation is a problem. Three quarters of consumers said rising prices are the most vexing issue facing the country, and the partisan split was described as “small” (72% of Democrats and 83% of Republicans).

That mirrors bipartisan support on Capitol Hill for measures aimed at arresting price pressures. Although not everyone agrees on the best way to approach the problem, the Fed is generally expected to lead the charge, considering it is their mandate. The concern is that monetary policy is ill-equipped, too late or both.

Richard Curtin, chief economist for the Michigan survey, painted a dreary picture, as he’s wont to do from time to time. “While supply chains and essential workers sparked the initial increases in prices and wages, a wage-price spiral that has subsequently developed is no longer tied to those precipitating conditions,” he said Friday, before warning that “household spending had been supported by an extraordinary pace of rising home and stock prices that is likely to turn negative in the year ahead.”

Assuming you own stocks and a house (or two), the pandemic was an economic windfall of historic proportions (figure below).

Household net worth exploded by more than $34 trillion thanks to America’s new property bubble and an epic, stimulus-fueled stock surge.

As I not-so-gently reminded readers last month, a slim majority of Americans have nothing to speak of. No property, no stocks and very little in the way of savings. So, headlines touting a $34 trillion gain for “households” are exceptionally misleading.

But even if you do own real estate and stocks, the pace of home price appreciation is starting to slow and the S&P is mired in its worst monthly slump since the onset of the pandemic (figure below).

While I’d be cautious about positing any mechanical read-through from falling stock prices to overall consumption (given that financial assets are concentrated in the hands of those with the lowest marginal propensity to consume), it’s certainly not a stretch to suggest that tales of “crashes” on Wall Street could further erode already fragile sentiment.

Crucially (and this was, to my mind anyway, the most important takeaway from the color accompanying the final read on Michigan sentiment for this month), Curtin suggested the Fed might end up doing more harm than good because the general public simply doesn’t understand all that much about monetary policy.

“Although their primary concern is rising inflation and falling real incomes, consumers may misinterpret the Fed’s policy moves to slow the economy as part of the problem rather than part of the solution,” Curtin said. Consumers, he fretted, “may overreact to tiny nudges, especially given the uncertainties about the coronavirus and other heightened geopolitical risks.”

As for whether the Fed can mitigate that by communicating clearly and otherwise attempting to prepare both markets and the public for policy tightening, Curtin was dubious. “Clear policy communication is insufficient if it does not also advance consumers’ understanding of the economic tradeoffs involved and their plans to actively alleviate any undue harm,” he warned.

Time and again in these pages I’ve suggested Fed hikes might not work as efficiently as economists and pundits imagine when it comes to short circuiting the expectations channel. If consumers don’t know who Jerome Powell is (or what the Fed does), it’s ludicrous to expect they’ll change their view on the likely trajectory of inflation when higher prices are staring them in the face at the grocery store and at the gas pump.

The Fed can always engineer demand destruction, but that brings us right back to Curtin’s point: It could very well be that the majority of American consumers will only (or primarily) acknowledge the impact of tighter Fed policy on demand, without making the connection between slower growth and the Committee’s desire to bring down prices. Regular people don’t listen to FOMC press conferences, and even if they did, Powell isn’t an effective communicator.

Expect this to become a problem in relatively short order. Unless you believe the general public is hard at work studying the history of monetary policy and weighing the merits of demand destruction versus the corrosive effects of entrenched inflation.