When it comes to economic news and its impact on the markets, sometimes bad news is good news — or if not good, at least not entirely bad news.
For example, the University of Michigan’s monthly survey of consumer sentiment is widely considered a key indicator of consumer attitudes. It’s also one of the many reports the Federal Reserve monitors as it decides what to do about the federal funds rate.
The university’s latest report was released on Friday, and it showed a significant decline in consumer sentiment. That would normally be considered bad, and it probably is for the economy. However, the markets were up on Friday. Here’s why.
Biggest drop in consumer sentiment in six months
As the Federal Reserve leaders have been saying all week, interest rates won’t be cut until inflation starts coming down, and inflation won’t start dropping until the economy slows down and/ or the labor market cools.
Of course, investors desperately want interest rates to come down. Lower rates make it cheaper for companies to borrow, spurring more investment, which could boost earnings. Lower interest rates also make it cheaper for consumers to borrow, which is good for banks and leads to more consumer spending, among other things.
When companies are investing and consumers are spending, it’s good for the markets and the economy. However, for rates to come down, the Fed needs the economy to slow down so that prices fall and inflation rates decrease, finally hitting the established 2% target.
If all of that sounds confusing and counterintuitive, it is — on both counts.
This leads us to the University of Michigan’s Survey of Consumers. The May results show that the index fell 13% to 67.4 from 77.2 in April. It is the lowest score since November, when it was 61. The index had been between 77 and 79 through the first four months of the year.
“This 10-index-point decline is statistically significant and brings sentiment to its lowest reading in about six months. This month’s trend in sentiment is characterized by a broad consensus across consumers, with decreases across age, income, and education groups,” Survey Director Joanne Hsu said.
Further, the index of consumer expectations was at 66.5, down 12.5% from 76 in April, so it is trending even lower.
“While consumers had been reserving judgment for the past few months, they now perceive negative developments on a number of dimensions. They expressed worries that inflation, unemployment and interest rates may all be moving in an unfavorable direction in the year ahead,” Hsu added.
What does it all mean?
This is obviously not good news for the economy, but it could be considered a positive development for the markets and longer-term economic growth.
That’s because if the economy does slow down, it will lead to lower inflation, which will lead to the Fed cutting rates. Of course, when the Fed cuts rates, the markets will go up, and the economy will start to improve. That’s the thinking anyway.
It had been a bit of a conundrum to Fed officials that the economy had not slowed down through the rate-hiking cycle last year, as Minneapolis Fed President Neel Kashkari expressed this week.
Meanwhile, Richmond Fed President Thomas Barkin stated this week that the full impact of higher rates on the economy has not yet come. Maybe this is a sign that it is coming — and that’s … good?
