Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Ignores Record-Low Consumer Sentiment
Transcript
- Lucas: Consumer sentiment hit a record low in May. The University of Michigan survey — the longest-running measure — fell to its lowest level since the early 1980s, driven by war-driven inflation worries and tariff uncertainty. And yet the Fed is sitting at 3.64 percent, not moving. That gap is today's puzzle. Luna: It seems odd on its face. If consumers are that miserable, why isn't the Fed cutting rates to stimulate the economy? Lucas: Right, and that's the instinct. But the Fed doesn't target consumer sentiment. It targets inflation and maximum employment. And on those two fronts, the data is telling a different story. Core PCE, the Fed's preferred inflation gauge, stood at 129.3 in March — up from 128.9 the month before. That's not collapsing. It's sticky. Luna: So the Fed sees the sentiment numbers but basically files them under 'interesting, not actionable'. Lucas: Exactly. And this isn't new. Historically, consumer sentiment has been a noisy indicator for the actual path of the economy. During the 2021-2022 inflation surge, sentiment plunged to all-time lows even as GDP grew, jobs boomed, and wages rose. The Fed learned not to overreact. Luna: But there's a political angle too, right? Kevin Warsh is the new chair. He's under pressure from bond vigilantes. If he cuts rates just because consumers are grumpy, the bond market might punish him by pushing yields higher. Lucas: That's the constraint. The ten-year yield is at 4.48 percent, down a bit this week, but still elevated. The bond market is essentially saying, 'We don't trust inflation is beaten.' If the Fed cuts before inflation is clearly trending down, long-term rates could spike, tightening financial conditions — the opposite of what a cut is supposed to do. Luna: So the Fed is boxed in by the bond market. But also by the data itself. What are they watching instead of sentiment? Lucas: They're watching core inflation, wage growth, and the labor market. Let me give you one specific number. The Atlanta Fed's wage tracker — which measures median hourly wage growth for all workers — is running around 5.2 percent year-over-year as of the latest reading. That's too hot for the Fed to declare victory. If wages keep rising at that pace, services inflation stays sticky. Luna: And yet small caps are roaring. The Russell 2000 is up 3.6 percent in the last five days. That's not a market that's screaming recession. Lucas: That's the paradox. Small caps — which are more domestically focused and more sensitive to interest rates — are rallying because the Fed is not cutting, but also not hiking. They've priced in a stable rate environment. And the economy, despite consumer sentiment cratering, is still adding jobs. The April payrolls report showed solid gains. So the Fed has room to wait. Luna: Let's talk about the yield curve. It's still inverted — the two-year yield is above the ten-year. That's been flashing recession for over a year. But the economy hasn't tipped over. Does that mean the curve is wrong, or just early? Lucas: It's been early before. The curve inverted in late 2022, and the recession many predicted never came — or if it did, it was the mildest on record. What matters for the Fed is the message from the short end: the two-year yield, at 3.59 percent, is still below the fed funds rate. That tells you markets expect the Fed to cut eventually, but not urgently. Luna: So the Fed is basically saying, 'We'll wait until we see the whites of inflation's eyes'? Lucas: I think that's right. And the next FOMC meeting is in June. The market is pricing in a roughly 30 percent chance of a cut. I doubt they move. The data just isn't there yet. And Kevin Warsh, in his recent speeches, has emphasized patience. He's not going to panic over a sentiment survey. Luna: Speaking of patience — for listeners who find value in walking through the economy with us each episode, keeping this show ad-free takes a little support from the audience. If you've gotten something out of this conversation, you can buy us a coffee at buy me a coffee dot com slash fexingo. It helps us keep digging into these angles without any sponsors. Lucas: Absolutely. And we appreciate every bit of it — it lets us stay independent. So back to the Fed's dilemma: there's also the tariff factor. The new tariffs on Chinese goods and potential Europe tariffs are feeding into import prices. That's a supply-side shock that the Fed can't offset with rate cuts. Cutting would just add demand-side stimulus to a supply-constrained economy, risking more inflation. Luna: So tariffs complicate the picture. They push up prices, but also hurt growth. The Fed is caught between a rock and a hard place. Lucas: Exactly. And that's why they're data-dependent rather than sentiment-dependent. They need to see how tariffs actually flow through to core inflation. The latest CPI, released for April, showed headline CPI at 332.4, up from 330.3. Core CPI, excluding food and energy, rose to 335.4 from 334.2. That's still above target. Luna: And the ten-year breakeven inflation rate — which is the market's expectation for average inflation over the next decade — is at 2.39 percent. That's a tick down from 2.40, but still above the Fed's 2 percent target. So the market doesn't believe inflation is fully tamed. Lucas: Which brings us back to the sentiment puzzle. If consumers are so pessimistic, why aren't they cutting back spending? Because sentiment doesn't always translate to behavior. Retail sales have been resilient. People are still spending, even if they're grumpy about it. That's the key insight for the Fed. Luna: So the Fed watches what people do, not what they say. Lucas: Exactly. And that's why they can afford to ignore the record-low sentiment for now. The real risk is if sentiment starts to feed into actual spending cuts — then you'd see it in GDP and payrolls. But we're not there yet. Luna: One more thing — the Fed's own surveys. The Senior Loan Officer Opinion Survey, or SLOOS, showed banks tightening lending standards, but not dramatically. That's a lagging indicator. So the Fed is monitoring credit conditions, but they're not flashing red. Lucas: Right. And the Fed's own Beige Book, which is anecdotal, shows some softening but no collapse. So the hawks on the FOMC can argue for holding steady. The doves want to cut to support the economy, but they don't have the data to win the argument. Luna: So the bottom line: the Fed is stuck at 3.64 percent until inflation convincingly moves lower, regardless of how consumers feel. And that might take several more months. Lucas: I think that's the most likely path. Unless we get a sudden spike in unemployment or a credit event, the Fed holds into the fall. And by then, we'll have a clearer picture of how tariffs and the war in Iran are affecting the economy. Luna: It's a waiting game. And the bond market is the timer. Lucas: Exactly. And we'll be watching every tick.