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Weathering the storm

| May 31, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Since the trade negotiations between the U.S. and China broke off in early May, financial markets have taken the news hard.  Equity indices are down by more than 5%, Treasury yields have plunged and risk spreads have widened. In contrast, consumers so far appear to be taking the news with surprising calm. Various gauges of consumer attitudes held up reasonably well in May, which bodes well for a continuation of solid growth in consumer expenditures.

University of Michigan sentiment

Traditionally, between the two major monthly consumer confidence surveys from the Conference Board and the University of Michigan, the Michigan survey would be more likely to detect trade worries. It asks more questions about the general economic outlook and solicits more detail.  The preliminary May survey, which ran through about mid-May with at least half the responses coming after the initial breakdown in trade negotiations, revealed a jump in the headline sentiment gauge of roughly 5 points, bringing the index to 102.4, the best reading since 2004 (Exhibit 1).  However, the revised figure, incorporating responses gathered throughout May, was somewhat less positive at 100.0 (see Exhibit 1).  Even so, the headline gauge was up by nearly 3 points in May to a level just a point or so below the 2018 high.

Perhaps most surprisingly, it was the expectations component that drove the May advance, with the 1-year ahead economic outlook surging by 15 points and the 5-year ahead outlook rising by 12 points, a stark contrast to the thinking in U.S. financial markets.

Exhibit 1: University of Michigan sentiment index

Source: University of Michigan

The preliminary May University of Michigan report noted that the proportion of respondents citing tariffs peaked in July 2018 at 35% and has fallen since, hitting a recent low of 15% in April and only ticking up to 16% in early May.  However, the news headlines over the course of the month have begun to pierce the collective consciousness of consumers.  By the end of May, the University of Michigan reported that the percentage of respondents citing tariffs had jumped back to 35%, matching last year’s high.

Even so, consumers do not seem very worried about the economy.  Fifty-nine percent of respondents in May expected “good times” during the year ahead, the highest figure in over four years, while the proportion expecting an economic downturn in the next five years declined to 38%, the lowest reading since 2004.

In fact, University of Michigan survey respondents appeared more worried about the inflation impact of tariffs than the growth drag.  Inflation expectations for the year ahead jumped by 0.4 percentage points to 2.9%, with respondents who mentioned tariffs as a negative development having expectations that were a half percentage point higher than those who failed to cite tariffs.

Conference Board

The Conference Board survey is done monthly by mail.  The May results, published on May 28, had a cut-off date of May 16.  The Conference Board questions focus more on employment, and the composite index is typically less reactive to financial market moves or news such as the recent trade talks.

The Conference Board measure of consumer confidence also increased by about 5 points in May, building on a hefty gain in April.  The 10-point rebound in April and May almost fully retraced the deterioration in attitudes registered around the turn of the year (Exhibit 2).

In contrast to the University of Michigan details, the May Conference Board was driven mostly by more upbeat views on the current situation, with that component rising to the highest level since 2000.

Exhibit 2: Conference board consumer confidence

Source: Conference board

Bloomberg Consumer Comfort Index

The Bloomberg consumer comfort index provides an even timelier measure of consumer attitudes, as it is released weekly  as 4-week trailing averages.  This gauge, much like the higher-profile monthly indices, has performed well in May.

The latest reading, for the week ended May 26, advanced by half a point, the third consecutive weekly increase covering the entire period since the trade talks initially broke down.  The index has nearly rallied back to the 19-year high posted in early March (Exhibit 3).

Exhibit 3: Bloomberg consumer comfort index

Source: Bloomberg

No victory laps yet

The evidence so far is quite encouraging that the consumer is not going to be greatly affected by the trade news.  However, it is early yet.  The news headlines continue to expose households to the apparent deterioration in the prospects for a deal, so it would probably be wise to wait another month and see how attitudes evolve in June before declaring victory. The modest deterioration in the University of Michigan sentiment measure from mid-May to month-end certainly suggests that there is potential for attitudes to shift in June.

One reason to believe that consumers may be insulated from the trade talks, at least for now, is that the tariff hike on Chinese goods announced in May is mostly on industrial supplies and other goods purchased by businesses.  High-profile consumer items such as cell phones were purposefully left off the list when these tariffs were first implemented last year.  If the Trump Administration ultimately imposes tariffs on another large group of items, as has been threatened, then the consumer will likely begin to feel a little pain.  Likewise, the latest news of 5% tariffs on goods imported from Mexico, while unlikely to make much of a difference right away, could eventually start to bite if they are raised substantially.  Still, up to now, the Administration has sought to keep U.S. consumers out of the fray for the most part, and the latest consumer confidence data suggest that the effort has largely succeeded.

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