Americans' anxiety about inflation is decreasing, as shown by the cooling consumer price index in May and a drop in forward-looking inflation expectations in the New York Fed's survey. The median one-year-ahead inflation expectation fell from 3.6% to 3.2%, while three-year and five-year expectations also declined.
This shift marks a convergence between 'hard' economic data (inflation and employment figures) and 'soft' data (consumer sentiment and expectations), which were previously at odds. While 'hard' data showed improvement, 'soft' data indicated pessimism. This convergence suggests a more optimistic outlook.
Wall Street has been focused on the positive 'hard' data, leading to a recovery in stock markets and a reduction in recession expectations. Strategists are recalibrating inflation predictions, with some believing that the inflation spike due to tariffs will be temporary.
Consumer confidence also rebounded in May, indicating a shift in sentiment. This improved outlook, mirroring Wall Street's, could positively impact consumer spending, preventing a recession and boosting markets. Pessimistic consumers had previously reduced discretionary spending.
The article emphasizes that consumer sentiment, while reflecting past events, can influence future economic outcomes. Improved sentiment could stimulate spending, contributing significantly to GDP (approximately two-thirds) and supporting economic growth.
Americans are finally starting to feel less anxious about inflation.
Consumer price index data showed inflation cooled in May. That comes alongside a brightening of inflation expectations in the latest survey data.
The New York Fed's survey of consumer expectations, published on Monday, showed that consumers' forward-looking inflation outlook declined in May for the first time this year.
The median one-year-ahead inflation expectation decreased, dropping from 3.6% in April to 3.2%. Three-year-ahead and five-year-ahead inflation expectations also declined, falling from 3.2% to 3.0% and from 2.7% to 2.6%, respectively.
The survey marks a turning point in the gap between "soft" and "hard" economic data, with the vibes in the economy starting to more closely align with the facts on the ground.
Inflation and labor market data have been looking more and more upbeat, but forward-looking gauges like inflation expectations and consumer sentiment have headed in the opposite direction.
Last Friday's jobs report also showed higher-than-anticipated job creation and unemployment levels hovering near historic lows. Yet, May's University of Michigan consumer sentiment reading plunged to from 52.2 to 50.8, the second-lowest reading ever recorded.
Wall Street has been more focused on the hard data.
May was a strong month for markets as slowing inflation and US-China trade relations led stocks to recover their Liberation Day losses. Recession expectations have come down from 60% to as low as 30% among some forecasters.
As stocks continue to gain after April's peak tariff volatility, strategists are also recalibrating their inflation expectations. While inflation could spike later this summer, as it could take three months or more for retailers to pass on tariff-related price increases to consumers, Goldman Sachs believes inflation will only see a temporary uptick from tariffs in 2025 before heading back down in 2026.
Now, it seems like consumers are finally getting on the same page. In addition to the improved inflation outlook reported by the New York Fed, the Consumer Confidence Index rebounded, increasing 12.3 points in May to 98.0 — its first increase after falling for five consecutive months.
Goldman Sachs said that for past event-driven recessions, soft data has usually bottomed around 60 days after a catalyst. As Liberation Day moves further into the rearview, Americans appear to be adjusting their economic outlooks.
Darrell Cronk, chief investment officer of Wells Fargo, echoed this perspective.
"What people forget is that sentiment is a reflection of what has happened already, not what will happen in the future," Cronk said during the bank's midyear outlook conference on Tuesday.
More optimistic sentiment could be a tailwind for markets, according to Goldman Sachs. Pessimistic consumers have pulled back on spending, especially in discretionary categories like airfare and travel.
With consumer spending making up roughly two-thirds of GDP, sentiment improvement could help prevent a recession and boost markets.
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