Introduction to Inflation and Consumer Sentiment
Consumers’ expectations for inflation dropped in May for the first time in 2025. This shift in consumer sentiment is significant, as it indicates that Americans are starting to feel less anxious about inflation. The consumer price index (CPI) data showed that inflation cooled in May, which, alongside the brightening of inflation expectations in the latest survey data, suggests a turning point in the gap between "soft" and "hard" economic data.
Understanding Inflation Expectations
The New York Fed’s survey of consumer expectations published on Monday showed that consumers’ forward-looking inflation outlook declined in May for the first time this year. The median one-year-ahead inflation expectation decreased from 3.6% in April to 3.2%. Similarly, three-year-ahead and five-year-ahead inflation expectations also declined, falling from 3.2% to 3.0% and from 2.7% to 2.6%, respectively. These declines in inflation expectations are crucial, as they reflect consumers’ perceptions of future economic conditions, which can influence their spending habits and overall economic activity.
Gap Between Soft and Hard Economic Data
There has been a notable gap between "soft" economic data, such as consumer sentiment and inflation expectations, and "hard" data, including jobs reports and CPI numbers. While inflation and labor market data have shown upbeat trends, forward-looking gauges like inflation expectations and consumer sentiment have moved in the opposite direction. However, with the recent improvements in inflation outlook and consumer sentiment, it appears that this gap is starting to close.
Consumers Catching Up to Wall Street
Wall Street has been focused on the hard data, which has shown strength, particularly in the labor market. The May jobs report showed higher-than-anticipated job creation, and unemployment levels have hovered near historic lows. As a result, recession expectations have come down among forecasters. Now, consumers seem to be adjusting their economic outlooks more in line with the positive trends observed in the hard data. The Consumer Confidence Index rebounded, increasing 12.3 points in May to 98.0, which marks its first increase after falling for five consecutive months.
Impact on Markets and Economy
Improved consumer sentiment can have a positive impact on markets and help prevent a recession. Consumer spending makes up roughly two-thirds of GDP, so an improvement in sentiment could lead to increased spending, particularly in discretionary categories. This, in turn, could boost markets and contribute to economic growth. Darrell Cronk, chief investment officer of Wells Fargo, noted that sentiment is a reflection of past events, not future ones. Therefore, as sentiment improves, it could act as a tailwind for markets, especially if consumers begin to spend more optimistically.
Conclusion
The recent decline in inflation expectations and the improvement in consumer sentiment are positive signs for the economy. As consumers become less anxious about inflation and more optimistic about their economic prospects, they are likely to increase their spending. This could help prevent a recession and boost markets. With the gap between soft and hard economic data narrowing, it seems that both consumers and Wall Street are aligning their expectations with the positive trends in the economy. As the economic outlook continues to evolve, monitoring consumer sentiment and inflation expectations will remain crucial for understanding the direction of the economy and making informed decisions about investments and economic policy.
