The Economy Runs on Confidence—And We’re Starting to Run Low

If consumers aren’t confident, they don’t spend. And when they don’t spend, GDP tanks.

KEY TAKEAWAYS

• Confidence drives consumption, and consumption makes up two-thirds of GDP.
• Government job cuts are already affecting 256,000 workers, with projections hitting 575,000 by year-end.
• A wave of new job seekers will increase labor supply, pushing wages lower.
• Consumer confidence just took its biggest monthly hit since 2022, a major red flag for future economic weakness.
• While cutting the deficit is important, aggressive job cuts can trigger bigger economic problems than they solve.

MY HOT TAKES

• Austerity sounds good—until it wipes out jobs and confidence.
• People don’t stop spending because they’re unemployed; they stop spending when they fear unemployment.
• If confidence keeps dropping, expect businesses to start pulling back, too.
• Half a million job losses don’t just hurt those workers—they ripple across the entire economy.
• The government needs to balance cutting waste with avoiding self-inflicted economic wounds.

Finding courage. My regular readers knew this one was coming—sorry. What would it take to shake your confidence? I am not talking about getting jilted by a lover. There’s that, sure, but because this is a finance, market, and economic blog, we will focus on something else. I would suspect that a marked change in your financial well-being could have a material impact on your confidence. Most of us rely on income to pay for life’s needs and wants. A more recent (last 25 years or so) addition is income from the stock market. We won’t talk about that today though. Today we will focus on income.

If you suspect that your income might be cut or gone completely in the near future, how would you react? Well, you would probably put off spending on large-ticket items. Maybe you would put off that vacation you were planning. You know, the wanna-haves. If your income was cut partially or completely, you would most likely cut further and even assess which of your gotta-haves might have to be cut from your budget. The point is that your employment situation has a direct correlation to how much you consume. OHHHH there it is—consumption.

Sorry, if I have explained this concept dozens and dozens of times, but it is that important. CONSUMPTION MAKES UP 2/3 OF GDP! If Americans are losing jobs, they will be spending… consuming less. Less consumption means lower GDP. Please tell me you got this. I need this to be clear. I also need you to understand that this is not some nebulous connection. Every dollar that you spend adds $0.75 to US GDP. Um… also, every dollar you don’t spend, takes away $0.75 from GDP. So now, I hope, that you understand why economists and Wall Street are so obsessed with the employment situation. That is also why healthy employment makes up 50% of the world’s most powerful financial institution, The Federal Reserve’s raison d'être. That’s right, the Bank’s sole concerns are 1) maintain a healthy labor market, and 2) keep inflation in check.

Staying with the labor market theme for now, the current labor market is relatively healthy at the moment. The last reading of the unemployment rate was 4.0% which is low by historical standards. Other than the few years prior to the pandemic, the rate had not been this low since 2000, and before that, the late 1960s. So why worry, right? Here is the curious thing about the relationship between the unemployment rate and GDP. Unemployment does not precede a recession; it usually results from a recession. Remember, the unemployment rate has nothing to do with GDP, rather, it is consumption. Yes, one consumes less when unemployed. But there is something that precedes all of that. Confidence! As we discussed earlier, if confidence wanes, lower consumption surely follows.

Let’s change the scene to Washington DC for a moment. Before I go a step further, I want to make it clear that the government must mind its purse the same as you and I. It is not entitled to waste just because it can endlessly borrow. And besides it’s yours and my tax dollars that it spends first, so the Government needs to be judicious with our tax dollars. Ok, that’s out of the way.

In its pursuit of a more mindful budget, the current administration has employed the Department of Government Efficiency, DOGE, to find savings in order to lower the deficit, and ultimately the country's debt. A noble cause. As you might guess, the government’s budget is a bit more complicated than your home budget. It’s not as simple as cutting out that gym membership that you never use anyway. But to be clear, there are probably a few of those easy-to-cut wasteful spendings. If you didn’t know, you might assume that there would be plenty of waste in a $6.75 trillion budget. And considering that $1.83 trillion of that is deficit spending, you might assume that it may even be simple to cut some or all of that and get the US into a budget surplus. In fact, last October, Elon Musk, the not-head of DOGE claimed that he could cut $3 trillion off the government’s butcher bill. Ambitious, but hey, if he can get it done, we will all be better off. Of course, Musk has since moderated his initial claim to $1 trillion. Easy peasy, right?

Well, DOGE is now in full swing, and to date, it claims to have saved some $55 billion in spending through the termination of some 1,100 contracts amounting to around $8.6 billion. That represents around 16% of the reported savings. Where did the other 84% come from? I am sure that there are some very obvious cuts in the remainder. But let’s be honest, the bulk of those alleged savings has come from job terminations. While we are being honest, let’s remember that those 1,100 contracts cancelled are likely to produce job cuts in the near-term as well. Based on the rapid deployment of these efforts, it is likely that some babies have already been thrown out with the bathwater. But the question is, how many more babies will be lost in the remaining $945 billion of DOGE’s $1 trillion target reduction. Forget that for a minute, and let’s go back to the numbers.

According to estimates from the smart folks over at Bloomberg Economics, roughly 256,000 jobs have been affected by DOGE’s efforts; that’s including 97,000 federal employees and the remainder contractors. Those are to-date numbers, mind you. Bloomberg estimates that the total number can hit 575,000 losses by year end. That could push the unemployment up by almost a whole percentage point and shrink the GDP by as much as 2.0 percentage points by mid-2026. That makes sense, right? People out of work must cut back on consumption. We have already established that.

But what about folks that haven’t lost their jobs yet? Will all this have an effect on them? Around 4% of the US labor force works directly for the US Government and for contractors to the Federal Government. Another 13% or so work for State and Local governments, which are also heavily reliant on the Federal government for funding. That amounts to some 17% of the US labor force that is now at least somewhat concerned about their future employment stability. What if you don’t work for the government? No problem for you, right? Nope. All those out-of-work folks are going to have to get civilian jobs—competing with you. That’s right, there will be a flood of labor supply. You know what that means in economic terms? Wage pressure for all. And when I say wage pressure, I mean lower wages and wage growth. More workers pursuing less available jobs!

That all amounts to a loss of confidence… consumer confidence. I have been quoted many times as saying, “confident consumers consume.” I could also phrase that like “unconfident consumers don’t consume,” but that doesn't sound as snappy. So, do you think that consumers’ confidence will be affected by all this seemingly ham-handedness going on in DC? Well, according to yesterday's Conference Board Consumer Confidence Report, it already has. The number came in with the largest single month drop since 2022. Notable was a large deterioration in employment outlook and an increase in the expectations for a recession. A sub-index of business, income, and labor expectations dropped to 72.9 from 82.2 a month earlier; numbers less than 80 are associated with a recession.

Am I pulling the alarm saying that we are going to have a recession? No, by no means, but I am telling you that every action has a reaction, and to expect that simply firing half a million workers may have more far-reaching, negative impacts than one might assume. Am I saying that cutting the deficit cannot be done? No, by no means, and it must, but it may not be as simple as sending out mass emails and aggressive layoffs. Remember that quote about the road to hell and good intentions? I will leave you with this chart of Consumer Confidence (blue line) with recessions (red shaded areas) going back to well, my birth year. Don’t mind the actual level of Consumer Confidence but do mind how clearly declines in confidence always precede recessions. Have a nice day.

YESTERDAY’S MARKETS

Stocks were able to claw back early session losses to close mixed to lower after Consumer Confidence missed analyst estimates big time, sounding recession alarms. Hardest hit were tech stocks which were dragged down by more tariff and trade talk from the administration. Bond yields continued their decline as recession fears climbed.

NEXT UP

• New Home Sales (January) may have declined by -2.6% after climbing by 3.6% in December.
• Fed speakers today include Tom Barkin and Raphael Bostic.
• Important earnings announcements today: Lowe’s, Advance Auto Parts, Lantheus Holdings, NRG, TJX Cos, Agilent, Snowflake, C3.ai, Sweetgreen, eBay, NVIDIA (after the close), Teledoc, Salesforce, Synopsys, Nutanix, Beyond Meat, Serepta, and Paramount Global.

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