Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Consumer Sentiment Hits Record Low as War Fuels Inflation Worries
Transcript
- Lucas: Consumer sentiment hit a fresh record low this week. That's not hyperbole — the University of Michigan survey for May came in at the lowest level ever recorded, and the headline is hardly a surprise given what's happening with the Iran war and the spillover into energy prices. Luna: Record low in absolute terms? Or just since the pandemic? Lucas: Absolute. The index fell to a level that even beats the 2008 financial crisis lows and the 1980 inflation spike. We're talking about a reading that says consumers are, by their own reporting, more miserable about the economy than at any point in the survey's history. Luna: Okay, but we also have the stock market at all-time highs. The S&P 500 closed at 7,500 today, the Dow above 50,000. So there's this huge disconnect between what Main Street feels and what Wall Street is doing. Lucas: Exactly, and that gap is one of the most important stories right now. The S&P up more than 1% in the last five days, the Russell 2000 up over 3% — small caps are ripping. But the consumer sentiment data suggests people don't believe the good times are durable. And when you look at the inflation data, you can see why. Luna: Let's look at the numbers. CPI for April came in at 332.4, up from 330.29 in March. Core CPI — stripping out food and energy — hit 335.4, also up. So inflation is still creeping higher, even before the full impact of the Iran conflict flows through. Lucas: Right, and the 10-year breakeven inflation rate — that's the market's implied inflation expectation over the next decade — actually dipped a bit to 2.39%, down from 2.44%. That seems counterintuitive. But I think what that tells us is the bond market is pricing in a demand destruction scenario. The war and the inflation are going to slow the economy enough that inflation eventually comes down, but at the cost of growth. Luna: And into this environment steps Kevin Warsh, the new Fed chair, sworn in just on Friday. His first real test is this sentiment collapse. Does the Fed even care about consumer sentiment? Lucas: Historically, yes, they do. The Fed's dual mandate is maximum employment and stable prices. Consumer sentiment feeds directly into both. If people feel terrible, they spend less, which hurts employment. And if they expect high inflation, they demand higher wages, which can become self-fulfilling. So Warsh cannot ignore this. Luna: But the Fed has been holding the federal funds rate at 3.64% since April, and the daily rate was 3.62 as of May 20th. They're on hold. What would push them to move? Lucas: The bond market is already doing some of the work for them. The ten-year Treasury yield fell to 4.57% today, down 1.2% over the past five days. The 30-year yield is at 5.08%, also down. So yields are dropping, which suggests the market is pricing in a slowdown — perhaps a recession — not more inflation. That gives the Fed some cover to stay put. Luna: Still, the core PCE — that's the Fed's preferred inflation gauge — came in at 129.3 for March, up from 128.9 in February. So inflation is sticky. And with the war, energy prices are likely to push it higher. Lucas: That's the dilemma. The Fed's interest on reserve balances rate is 3.65% — essentially the effective floor for rates. They are not in easing territory. But if the sentiment data keeps deteriorating, Warsh will face pressure to signal a pivot. The risk is that he moves too early and loses credibility on inflation. Luna: And the bond vigilantes — we've talked about them in prior episodes — they're watching. If Warsh blinks, they could push long-term yields higher, undoing any good from a rate cut. Lucas: Exactly. And there's another layer here. CNBC ran a piece this week about the AI economy rewriting the American dream and blue-collar workers poised to win. That's a long-term structural story, but in the short term, it complicates the Fed's job. If ai driven productivity starts boosting wages for manufacturing and logistics workers, that could keep inflation elevated even if consumer sentiment is lousy. Luna: So the Fed has to weigh a sentiment collapse, sticky inflation, war-driven energy shocks, and a potential productivity boom all at once. That's a lot for a new chair. Lucas: It really is. And the data we have today — the record-low sentiment, the CPI at 332.4, the breakeven rate at 2.39% — it all points to an economy that is bifurcated. Markets are partying because they think the Fed will save them. Consumers are hunkering down because they see higher prices and global instability. Luna: Who's right? The market or the consumer? Lucas: History says the consumer tends to be a lagging indicator. But when sentiment hits a record low, it often foreshadows a real downturn. The 1970s saw multiple sentiment troughs before recessions. The 2008 crash was preceded by a sentiment slide. I'm not saying we're headed for a crash, but this data is a yellow flag. Luna: And the Fed's next meeting is mid-June. Do you expect any change in language? Lucas: I think Warsh will acknowledge the sentiment data. He has to. But I expect him to hold the line on rates and emphasize that the Fed is data-dependent. The tricky part is that the data is contradictory: inflation says tighten, sentiment says ease. He'll likely punt and wait for more clarity. Luna: So more of the same? 'Patience' and 'data-dependent'? Lucas: Probably. But the risk is that by the time the data is clear, the economy may already be in a different place. The bond market is already pricing in rate cuts for late 2026. If Warsh doesn't push back against that, he could be seen as acquiescing to market pressure. Luna: And if he does push back, he risks spooking the market. It's a tightrope. Lucas: It always is. But this week's sentiment number is a signal that the ground is shifting. The Fed's next move — or lack thereof — will tell us a lot about how Warsh intends to navigate this crisis. Luna: Alright, we'll be watching the June meeting closely. Thanks, Lucas. Lucas: Thanks, Luna. And to our listeners — keep an eye on those breakeven rates. If they start rising again, that's the bond market saying the Fed isn't doing enough.