Consumer confidence has taken a hit in the United States as inflation expectations rise despite strong economic indicators, according to a survey released Friday.

The University of Michigan Consumer Survey revealed that the sentiment index for May recorded a significant decline, falling from 77.2 in April to 67.4. This figure falls short of the Dow Jones consensus estimate of 76, indicating a 12.7% monthly decline. But it still represents a 14.2% year-over-year increase.

In addition to the pessimistic sentiment measure, inflation expectations rose for both one- and five-year periods. The one-year outlook rose 0.3 points from a month ago to 3.5%, reaching its highest level since November. Similarly, the five-year outlook rose slightly by 0.1 points to 3.1%, reversing the downward trend in recent months and reaching the highest level in November.

Survey director Joanne Hsu noted that consumers now acknowledge negative trends on several fronts. “They expressed concerns that inflation, unemployment and interest rates may move in a negative direction next year,” Hsu said.

Other indexes in the survey also reported significant declines: The current conditions index fell more than 10 points to 68.8, while the expectations measure fell 9.5 points to 66.5. Although both indexes were higher than a year ago, they were down more than 12% on a monthly basis.

This report comes amid a strong stock market rally and fuel prices falling slightly, though still at high levels. Although jobless claims last week reached their highest level since late August, most labor market indicators remain strong.

Paul Ashworth, Chief North American Economist at Capital Economics, expressed concern about the significant decline in confidence. “The magnitude of the decline in confidence is significant and cannot be satisfactorily explained by geopolitical factors or the stock market sell-off in mid-April,” Ashworth wrote.

Inflation data pose a significant challenge for policymakers as the Fed considers the near-term path of monetary policy. Jeffrey Roach, Chief Economist at LPL Financial, warned: “Uncertainty about inflation could weigh on consumer spending in the coming months. “The Fed is on a difficult path to balance both its price stability and growth mandates.”

FED officials said at their meeting last week that they needed “more confidence” that inflation was “sustainably” returning to their 2% target before cutting interest rates. Policymakers see expectations as key to containing inflation, and the outlook from the Michigan survey has risen in consecutive months after falling significantly between November and March of this year.

Market pricing points to a strong expectation that the Fed will start reducing the key borrowing rate in September, which it has held at its highest level in more than 20 years since July 2023. However, the outlook varies, although FED Chairman Jerome Powell stated in the post-meeting press conference that the central bank’s next move will not be an interest rate increase.

The next important data point for inflation will come on Wednesday when the U.S. Labor Department releases its April consumer price index report. Most Wall Street economists expect the report to show a slight moderation in price pressures, but the widely followed CPI index was running at 3.5% annually in March, well above the Fed’s target.

*This is not investment advice.

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