Inflation battle drudges while consumer sentiment drops to record lows

Corroding consumer confidence

Morale is low. Consumer sentiment reached all-time lows, as measured by the University of Michigan. The measure has declined 41.5% since last June, reaching figures not comparable since 1980. Recession fears entered the forefront of consumer concerns. Per Google Trends, over the last 12 months, “recession” search entries recently peaked during the middle of the month and increased five-fold since May’s end. Recent indicators have not made the grass greener. Against expectations of a 0.1% increase, retail sales dropped 0.3% in May, the first decline since 2021. One of the market’s favorite recessionary indicators, an inversion of the 2-year and 10-year treasury curve, also revealed itself, albeit briefly, this month. Taking the 2-year’s place, the 5-year treasury briefly surpassed the 10-year rate last week. The volatility of the treasury market has been a growing driver for more aggressive rate hikes. These factors, amongst many more, have prompted the Atlanta Fed to drop second-quarter GDP estimates to 0% from +0.9%. If 0% proves too optimistic, the U.S. economy will officially meet the technical definition for a recession — two consecutive negative quarters of negative GDP. First-quarter GDP had declined 1.5%. Fed Chair Powell remarked on the realities of facing a recession last week. “It’s certainly a possibility,” he said. “It’s not our intended outcome at all, but it’s certainly a possibility, and frankly the events of the last few months around the world have made it more difficult for us to achieve what we want, which is 2% inflation and still a strong labor market.”

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Combating inflation

Inflation remains public enemy number one. This comes to no surprise to consumers as they’ve battled the highest gas and food prices in recent memory — gas prices rose 4.1% and food climbed 1.2% through the month. As for the Fed, the target has not been clearer and the challenge more difficult. "Fed rate hikes won't bring down gas or food prices,” Powell said last Wednesday. A lack of “precision tools” was noted and the realization of missed judgment from supply-side and COVID-19 difficulties eluded earlier action to fight inflation. Yet, Powell repeated that because of the strong labor market, the economy should be positioned to handle aggressive tightening. Job losses are possible though. Fed officials expect the national unemployment rate to rise to 3.9% by the end of 2023 and 4.1% by 2024’s end. Several analysts predict higher unemployment figures with stagflation as a worst-case scenario. Nevertheless, the Fed indicated that if supply-side problems are worked out, a soft landing could be possible. Time will tell how inflation cools down. Central banks across the globe are taking different approaches and one solution will surely not fit all. "The main thing is we can't fail on this. We really have to get inflation down to 2%," Powell instructed members of the House Financial Services Committee last Thursday. "We're going to want to see evidence that it really is coming down before we declare any kind of victory."

Looking ahead

Durable goods orders, initial jobless claims, personal income, and consumer spending figures are expected to be released next week. Markets will closely monitor energy supply developments across Europe as the Russian invasion continues to disrupt.