Consumer sentiment

and the siren song of the Fed

The University of Michigan’s preliminary report of consumer sentiment dropped today. It moved slightly higher to a reading of 71.0. This is good news after August’s dismal report of 70.3, which was a decade-low. Consumers still believe that the current economic conditions are poor. Buying attitudes for homes, vehicles, and household durable goods all fell to near all-time record lows. Consumers stated high prices as the reason why.

Complaints of higher prices led consumer inflation expectations to increase to 4.7% from 4.6% the month prior. Richard Curtin, Surveys of Consumers chief economist, laid out exactly who they are seeing complain about rising costs.

Although declining living standards were still more frequently cited by older, poorer, and less educated households, over the past few months, complaints about rising prices have increased among younger, richer, and more educated households.

The poor and those on fixed incomes are always the ones that notice inflation first. They have very tight budgets so when things like food, gas, and rent get expensive, they have to make difficult decisions. However, inflation is now starting to impact those with higher incomes. This is where things will start to get more interesting. Richard gives us the playbook.

Consumers have initially reacted by viewing the rise in inflation as transitory, believing that prices will stabilize or could even fall in the future. As a result, postponing purchases is seen as a viable strategy. This implies a slowdown of spending in the months ahead and a more robust rebound later in 2022.

If this is true then the people have been tricked by the siren song of the Fed.

In addition, the shortages we are seeing now are nothing compared to what could be ahead.

Richard posits that once consumers start to realize that this inflation is here to stay, they will begin to demand higher wages.

The main alternative is that inflation will not be transient but will rise further due to an unprecedented expansion in fiscal and monetary policies. The resulting rise in inflationary psychology will lessen resistance to rising prices and stiffen demands for increased wage gains. This reaction takes a long time to fully develop, and is contingent on significant increases in long-term inflation expectations, which have yet to be observed.

“Lessen resistance to rising prices” is a nice way of saying, ‘people are going to begin buying goods regardless of the cost’. In addition to demanding higher wages, I believe we could see people taking on second or third jobs and finding other ways to increase their income.

While Richard believes this could take a long time to materialize, short-term inflation expectations have already risen to decade highs and longer-term expectations are moving up.

A lot of this thesis hinges on the continued “unprecedented expansion” of fiscal and monetary policies. If the Dems run into trouble getting their massive budget and infrastructure bills passed, things would look quite different. Also, while the Fed’s taper is seen as important, interest rates play a bigger role. If the Fed starts to lift the rates, the inflation impact could be lessened. The economy rests on a knife’s edge and part of the reason we’ve seen such volatility in the market.