Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Consumer Sentiment Hits Record Low as Iran War Drives Inflation Fears
Transcript
- Lucas: So the University of Michigan consumer sentiment survey came out today, and it is genuinely ugly — a fresh record low, and not by a small margin. We're talking about a reading that undercut even the most pessimistic economist forecasts. Luna: I saw the headline. Record low in May, and the Iran war is the named culprit. But what's interesting is that the stock market didn't really flinch — the S&P 500 is up one point two percent over the past five days. Lucas: Right, and that's the puzzle we need to unpack. Because on the surface, you have consumers saying they feel worse than they did during the 2008 financial crisis or the COVID lockdowns. Yet equity markets are grinding higher, and the ten-year Treasury yield is sitting at 4.57 percent — actually down a bit over the past week. Luna: So is the market just ignoring the consumer? Or is it pricing something different? Lucas: I think it's more that the market suspects the consumer sentiment collapse is heavily concentrated in one specific channel — energy prices tied to the Iran conflict. If you look at the details in the Michigan survey, the year-ahead inflation expectations spiked to something like 5.3 percent. That's a huge jump. But the bond market's ten-year breakeven inflation rate actually dipped to 2.39 percent. So the bond market is essentially saying, 'This inflation spike is temporary — it's a supply shock from the war, not a demand-driven spiral.' Luna: That's a pretty sharp divergence. Consumers are panicking about gas prices today, but bond traders are betting the Fed won't have to hike aggressively because the shock will fade. And that's probably why the Russell 2000 is up three point four percent over the past five days — small caps, which are more domestically focused, might be pricing in that the worst of the inflation scare has passed. Lucas: Exactly. But here's the tension: Kevin Warsh gets sworn in as Fed chair this Friday. His first real test is going to be how he communicates about this exact gap — between consumer panic and market calm. If he leans too hard into the hawkish narrative, he risks tightening into what might already be a slowing economy. Real GDP growth annualized is only two percent — that's not bad, but it's not robust either. Luna: And the jobs data is mixed. Nonfarm payrolls are still growing — 158.7 million employed — but job openings have been slipping. JOLTS came in at 6.866 million in March, down from 6.922 million. So the labor market is cooling, just slowly. Lucas: That's the classic 'soft landing' scenario — if the Fed gets it right. But the consumer sentiment number suggests that whatever the macro statistics say, real people are feeling real pain at the pump. And that pain is political, and it's psychological, and it feeds into spending behavior. Luna: So what do you think Warsh does? He's inheriting a fed funds rate at 3.64 percent, which is already restrictive. Does he signal a cut? Does he hold? Or does he talk tough to contain those inflation expectations? Lucas: I think he holds and waits for more data. The fed funds rate has been flat for months. The interest on reserve balances is 3.65 percent. There's no urgency to move. But his words will matter enormously. If he acknowledges the consumer pain without committing to a cut, that might actually be the best outcome — it validates the fear without adding more fuel to it. Luna: One thing I keep coming back to: the breakeven inflation rate dropping while consumer inflation expectations spike. That's a fascinating disconnect. It almost feels like the bond market is saying, 'We trust the Fed's framework, but households don't.' Lucas: Yeah, and that's where credibility matters. If Warsh can convince markets that the Fed sees this as a transitory shock, the ten-year yield might drift lower, which would ease financial conditions. But if he sounds alarmed — if he hints at rate hikes — then you could see the yield spike and equities sell off. Luna: Look, this episode is exactly the kind of deep dive we try to bring you every day, and it's only possible because of listeners who support the show. We don't run ads — that's a deliberate choice. If you want to support that, buy me a coffee dot com slash fexingo is the place. Lucas: Even a small contribution helps us keep these conversations ad-free and accessible to everyone. We're grateful for every bit of support. Luna: Alright, back to the macro picture. Lucas, you mentioned the bond market's take. But what about the dollar? I haven't seen a big move there. Lucas: The dollar has actually been relatively stable through this whole Iran escalation. That's a bit surprising — typically a geopolitical shock in the Middle East sends the dollar higher as a safe haven. But maybe the market is already pricing in that the conflict stays contained to energy markets and doesn't spiral into a broader regional war. Luna: Or maybe the Fed's credibility is strong enough that the dollar doesn't need to jump. If the market believes the Fed can manage the inflation spillover, the dollar stays put. Lucas: Right. And that brings us back to the consumer sentiment number. If the Fed can manage expectations effectively, then the record low sentiment might be a peak pessimism signal — the kind of thing that reverses as soon as gas prices stabilize. Luna: But that's a big 'if.' The data we have today — CPI at 332.4, core PCE at 129.3 — shows inflation is still sticky. It's not accelerating, but it's not coming down fast either. Lucas: And that's why I think the next few weeks are critical. We get the May CPI report in mid-June, and then the Fed meeting. That CPI number will either validate the bond market's calm or blow it up. Luna: What's your baseline expectation? Lucas: I think headline CPI will moderate slightly because energy base effects will start to help. But core might stay elevated. That would give Warsh cover to hold rates steady and emphasize patience. The real wildcard is the jobs report — if payrolls start to soften meaningfully, then the conversation shifts from inflation to recession risk. Luna: And the initial jobless claims are already trending down — 209,000 last week, which is low historically. So the labor market is still tight, just not as tight as it was. Lucas: Exactly. That's the soft landing script: inflation slowly edges down, employment stays solid, the Fed stays on hold. The consumer sentiment number is the one outlier screaming that the landing might not feel so soft to the people actually living through it. Luna: Which is why I think Warsh's first speech after being sworn in is going to be so closely watched. He needs to acknowledge the pain without panicking the markets. Lucas: He's a skilled communicator — he's been in the policy world for decades. But this is his first real test as chair. The Iran war adds a layer of uncertainty that he didn't have to deal with at the start of his term. Luna: One more thing: the uk gulf trade deal that was announced — is that relevant to the inflation picture? Lucas: It's a positive signal for global trade resilience, but it's not a game-changer for US inflation. The US doesn't import much oil from the Gulf directly — we're more exposed through global prices. But any deal that stabilizes energy supply chains is helpful at the margin. Luna: So bottom line: record low consumer sentiment is a warning, but not a recession signal — yet. The bond market is betting on a transitory shock, and the Fed is likely to stay patient. But if the May CPI comes in hot, that calculus changes. Lucas: That's exactly where I land. And I think the most interesting thing to watch is whether the consumer sentiment recovers as quickly as it fell. If it does, then this was just a fear spike. If it stays low, then we have a real problem. Luna: We'll be tracking it. Thanks, Lucas. Lucas: Thanks, Luna. And to our listeners, we'll be back tomorrow with another episode.