Consumer sentiment fell in February to its lowest level in the past decade, according to the University of Michigan Surveys of Consumers.

Importantly, the loss was still entirely due to a 12.9% decline among households with incomes of $100,000 or more, a group that has a significant impact on consumer spending, said U-M economist Richard Curtin, director of the surveys.

The descent resulted from inflationary declines in personal finances, a near-universal awareness of rising interest rates, falling confidence in the government’s economic policies, and the most negative long-term prospects for the economy in the past decade, he said.

Virtually all interviews were conducted prior to the Russian invasion so its impact is yet to be felt by consumers. The most likely linkage to the domestic economy is through rising energy prices and the potential for retaliatory cyber disruptions of the economy, Curtin said. Much is unknown, however, about cyberwars that aim to inflict losses on home fronts rather than battlefields.

“The Russian invasion of Ukraine is likely to increase inflation and job losses. This makes the task of the Fed even more challenging,” he said. “Accelerating inflation has caused financial harm and growing angst among consumers, and prospects for retaliatory cyberattacks could cause added concerns about jobs and access to household funds. This will make finding the balance between the two Fed objectives even more difficult and more critical.

“Clinging to the transient hypothesis meant missed opportunities to nip inflation at its earliest stages. Even more aggressive actions are now needed to avoid the establishment of an inflationary psychology that can act as a self-fulfilling prophecy. Job growth may also be more vulnerable to the disruptions from cyberattacks and consumers may adopt more cautious spending preferences.”

Inflation challenge
The financial harm and growing angst among consumers about rising inflation have pushed nearly 9-in-10 consumers to anticipate interest rate hikes. The Fed’s clinging to the transient hypothesis meant missed opportunities to nip inflation at its earliest stages, Curtin said.

“More aggressive actions are now needed to avoid the potential establishment of an inflationary psychology that forms a self-fulfilling prophecy,” he said. “Nonetheless, the imposition of sanctions against Russia is likely to generate countermeasures that could harm the domestic economy, requiring the Fed to give special consideration to any associated economic slowdown and rising unemployment.”

Weakened economy anticipated
Consumers evaluated their current financial situation as the worst in nine years, and when asked about their future financial prospects, more households expected worsening finances than any other time since May 1980. Consumers focused on inflation-adjusted incomes, which have turned quite negative: a median expected gain in nominal incomes was 1.9% in February, far lower than the anticipated year-ahead median inflation rate of 4.9%.

Consumer Sentiment Index
The Consumer Sentiment Index fell to 62.8 in the February 2022 survey, down from 67.2 in January and well below last February’s 76.8. The Expectations Index fell to 59.4 in February, down from last month’s 72.0 and 16.0% below last year’s 70.7. The Current Conditions Index fell to 68.2, down from last month’s 72.0, and significantly below last year’s 86.2.

Although Consumer Sentiment posted a slight increase in the last half of February, it still remained at its lowest level in the past decade, and the loss was still entirely due to a 12.9% decline among households with incomes of $100,000 or more. The February descent resulted from inflationary declines in personal finances, a near universal awareness of rising interest rates, falling confidence in the government's economic policies, and the most negative long term prospects for the economy in the past decade (see the chart). Virtually all interviews were conducted prior to the Russian invasion so its impact is yet to be felt by consumers. The most likely linkage to the domestic economy is through rising energy prices, with the size and length of the potential increases subject to substantial uncertainty. This will complicate the Fed's policy actions, tilting their objectives to focus more on inflation at the cost of slower growth and higher unemployment. The financial harm and growing angst among consumers about rising inflation have pushed nearly nine-in-ten consumers to anticipate interest rate hikes. The Fed's clinging to the transient hypothesis meant missed opportunities to nip inflation at its earliest stages; aggressive actions are now needed to avoid the potential establishment of an inflationary psychology that acts to form a self-fulfilling prophecy. The imposition of sanctions against Russia is likely to generate counter measures that could harm the domestic economy, requiring the Fed to give special consideration to any associated economic slowdown and rising unemployment. Presumably, economic sanctions would be lifted only if Ukraine's sovereignty is maintained, but not if Russia prevails. Consumers may double-down on precautionary behaviors if the greater cyber risks associated with the conflict are now borne by domestic households.