Sentiment is sliding—can a Fed rate cut turn the mood?
KEY TAKEAWAYS
Consumption makes up two-thirds of GDP, making consumer sentiment critical
Conference Board survey emphasizes jobs, while University of Michigan emphasizes inflation and personal finances
Sentiment surveys are “soft data” and politically biased
Republican sentiment has begun to slip, while Democratic sentiment is holding steady
The Fed’s upcoming rate cut may test whether confidence can be boosted
MY HOT TAKES
Rate cuts are universally loved, but they’re not a cure-all
Consumer sentiment splits along political lines, distorting the overall picture
Soft data moves markets, even if it’s flawed
The real driver of the economy is confidence, not frosting from the Fed
The divergence in partisan sentiment is a flashing warning sign
You can quote me: “Confident consumers consume—and consumption makes up two-thirds of GDP.”
Who do you love? Who doesn’t love cupcakes? My son likes cupcakes; though his interest is somewhat unique. He actually only likes the cake, almost always eating around the cream topping. He is probably in the minority, and the good news is that there is almost always someone willing to stand in for him on the topping. Everyone loves a rate cut. Love for it transcends all those things that typically divide us as a society. Not everyone likes rate cuts for the same reason, but everyone loves em’, and this week the Fed is set to deliver.
How do you feel about the economy? What about your economic prospects for the future? Are you going to push go on that big family vacation, that new TV, or the home upgrade? Presumably, NOT if you are expecting to get laid off with weak prospects of landing a new job. Presumably, NOT if you expect your living costs to continue to skyrocket. And, presumably, NOT if you are worried that you won’t have enough retirement income. All these things fall under consumer sentiment.
My long time followers know that I am a bit obsessed with consumption because it has such a large impact on economic health. Consumption, which measures goods and services purchased by you and me, makes up ⅔ of GDP! How can we gauge consumption patterns in the future? Well, consumer sentiment, obviously. You know my old, oft-repeated saying: confident consumers consume!
There are two closely watched consumer sentiment gauges: Confidence Board Consumer Confidence and University Michigan Sentiment. The Conference Board’s Consumer Confidence index leans heavily on labor market views, asking more about jobs and current business conditions. The University of Michigan Sentiment survey focuses more on personal finances, inflation expectations, and household outlooks. Because of this, the Conference Board often runs stronger when jobs are plentiful, while Michigan tends to weaken when prices are rising. Both measure consumer mood, but they emphasize different drivers of confidence. Most importantly, together, they provide a fuller picture of how Americans feel about both their paychecks and their pocketbooks. It is therefore logical that, if you, like me, would like to know these very important numbers.
Simple, right? Well, of course not, nothing is simple–especially in the markets and the economy. The Fed refers to these sentiment numbers as “soft” numbers because they do not directly measure anything. They rely on surveys, and if we learned anything in the past 10 or so years, surveys are not always the best predictors. Look, there are very well-defined guidelines in academic statistics to determine if a survey is reliable, but even if those guidelines are strictly adhered to, their predictive capabilities always need to be taken with a grain of salt.
One of the major criticisms about consumer sentiment surveys is that they are politically biased. Could you imagine? Of course, you can, and, unfortunately, it’s true. Fortunately, the University of Michigan bifurcates the results by political party. Have a look at this chart and follow me to the close.
This chart shows University of Michigan overall consumer sentiment by Republican (red line) and Democrat (blue line). Can you see how clearly Republicans grew more confident late last year while confidence amongst Democrats fell precipitously at the same time. Would you be shocked if I told you that the crossover occurred when President Trump was elected? Of course, you wouldn’t. Overall University of Michigan Sentiment fell from 71.8 to 55.4 during that period. By looking at the chart however, you should be able to tease out the fact that much of the overall decline was influenced by Democrats’ sentiment.
Right now, we are at a clear economic inflection point. It would be hard to argue that the labor market is healthy at this point given the recent spate of weak employment figures. Employment health and expectations are a big part of the sentiment surveys, so one would expect the sentiment figures to reflect the recent decay of the labor market.
On Friday, we got the preliminary September sentiment numbers from the University of Michigan, and it would certainly appear, at first glance, that the decline in the labor force is taking effect. And it is. But now that you know about the split across political party lines, how do you expect that to be received? Well, my friends, the answer is on the right-hand side of that chart above. ☝️ You can clearly see how Republican consumer sentiment peaked in July and now appears to be in a shallow declining trend, while Dems seem to be mostly sideways. In fact in the latest survey sentiment amongst Democrats improved slightly month-over-month while sentiment declined amongst Republicans and Independents (not shown).
Could this mean that the President’s party is getting nervous about some of his aggressive trade policies, or does the recent decline simply reflect a normalization? It is far too early to tell, but when you see a divergence like this, it is worth noting. Can some of this decline in sentiment be stemmed off if the Fed resumes its rate-cutting later this week? What do you think? Cake, or creamy topping?
FRIDAY’S MARKETS
Stocks had a mixed close with the Nasdaq hitting another all-time high as traders wrestled with this week’s Fed decision. Bond yields gained slightly with 10-year tenors keeping yields above 4%.
NEXT UP
Empire Manufacturing (September) may have slipped to 5.0 from 11.9.
Later this week we will get Retail Sales, housing numbers, Industrial Production, more regional Fed reports, and the FOMC and its rate decision. Download the attached economic calendar for the week ahead so you know where to get the best cupcakes and when.