US consumer sentiment falls to 51 as inflation expectations rise

The University of Michigan's consumer sentiment index fell to 51.0 in early August, down from 55.2 in July and below the 54.5 consensus forecast, ending two consecutive months of improvement after the Iran conflict had pushed economic optimism to a record low. Both major components weakened, with the current conditions gauge dropping to 51.8 and the expectations measure sliding to 50.6.

"The early-month weakening in sentiment was pervasive across various demographic groups, with notably large reductions seen among older consumers, lower-income consumers, and those without a college degree," said Joanne Hsu, director of the Surveys of Consumers at the University of Michigan.

Year-ahead inflation expectations ticked up to 4.3 percent from 4.2 percent, while the five-year outlook held steady at 3.3 percent. Only 8 percent of consumers now expect their incomes to grow faster than inflation, down sharply from 18 percent in December 2024. Expectations for business conditions deteriorated 11 percent over the next year and 17 percent over the longer term.

The sentiment slump carries direct implications for the Federal Reserve's policy calculus. Consumer spending accounts for roughly two-thirds of U.S. gross domestic product, and a sustained deterioration in household confidence typically precedes softer consumption. The last time sentiment approached these levels was in June 2022, when the index bottomed at 50.0 — a period that preceded an aggressive rate-hiking cycle as the Fed prioritized inflation containment. The current trajectory differs in one critical respect: inflation is running well below the 9 percent peak of mid-2022, giving the Fed more room to respond to a demand-side slowdown.

Inflation expectations remain the key risk

The persistence of elevated year-ahead inflation expectations at 4.3 percent is particularly problematic for policymakers. The Fed has repeatedly indicated that anchored long-run expectations are critical to its credibility, and the unchanged 3.3 percent five-year reading offers some reassurance. However, the widening gap between short-term and long-term expectations suggests consumers see current price pressures as persistent rather than transitory. The 4.3 percent one-year reading remains well above the Fed's 2 percent target, and if it continues to drift higher, it could force the central bank to maintain restrictive policy even as growth slows.

The demographic breakdown of the August decline adds another layer of concern. Older consumers, lower-income households, and those without a college degree — groups most exposed to rising prices for essentials like food, energy, and housing — drove the deterioration. This pattern mirrors the 2022 inflation shock, when the same cohorts led sentiment lower before the Fed's tightening cycle took hold. The income expectations data is particularly striking: the share of consumers expecting income growth to outpace inflation has collapsed from 18 percent in December 2024 to just 8 percent, indicating that households are increasingly feeling the squeeze of elevated prices on their real purchasing power.

Republican sentiment fell to its lowest level in nearly two years, reflecting political polarization in how households perceive the economy. The partisan divide in consumer confidence has widened significantly since 2020, with Democrats and Republicans now differing by more than 30 points on the index — a gap that complicates the survey's usefulness as a pure economic indicator. The Iran conflict appears to have disproportionately affected Republican respondents, who tend to be more sensitive to geopolitical and foreign policy developments.

What this means for markets

The data adds to a growing body of evidence that the U.S. consumer is under strain. Retail sales data for July, due next week, will provide a more concrete read on spending. If sentiment weakness translates into softer consumption, economists expect downward revisions to third-quarter GDP growth estimates, which currently sit near 2 percent annualized.

For the Fed, the August survey reinforces the case for caution. Markets currently price roughly two rate cuts by year-end, but a consumer-led slowdown could accelerate that timeline. The next Federal Open Market Committee meeting is scheduled for September 16-17, where policymakers will have access to the final August sentiment reading and the August jobs report. If the September meeting delivers a cut, it would mark the first easing since the Fed began its tightening cycle in 2022.

The survey's forward-looking components are particularly telling. The 11 percent deterioration in one-year business condition expectations and the 17 percent drop in longer-term outlook suggest households are bracing for a prolonged period of economic weakness. If these expectations persist, they could become self-fulfilling, as consumers pull back on discretionary spending and businesses delay investment decisions.

This article is for informational purposes only and does not constitute investment advice.