The final May reading of the Thomson Reuters/University of Michigan Consumer Sentiment confirmed that the consumer mood remains on the road to recovery. Confidence levels surged in May to 84.5, well above April’s reading of 76.4, reaching a five-year high.
Since the beginning of the year, a resurgence of confidence has clearly emerged. A combination of falling gas prices, improvement in the jobs picture, and rising stock and home prices helped to lift consumer’s spirits in recent months. The relationship between consumer sentiment and consumer spending is a tenuous one, but a sustained improvement in the collective mood should be supportive of growth.
Contrasting the positive news on sentiment, today’s report on personal income and spending reinforced the fact that households are seeing very little in the way of income growth.
The lack of more robust income growth presents a real source of risk to consumer spending. Typically, a sustained surge in consumer sentiment bodes well for spending in the coming quarters, which should be unambiguously positive. That outcome will be more difficult to achieve if income growth doesn’t accelerate, as consumers may lack the resources to fuel that spending.
Consumers have slashed their savings to ratchet up spending, but tapping savings doesn’t represent an endless source of capital. In time, the ability of consumers to continue down that path will be exhausted. Better growth in household income is an increasingly critical ingredient to consumer spending and represents a real source of risk to the economy at some point.
While Fed policy has nudged the economy in the right direction, it’s not clear that a self-sustaining virtuous cycle is poised to take hold in the absence of these exceptionally accommodative policies. The good news is that with all signs pointing toward limited risk of inflation flaring in the near-term, the Fed remains well-positioned to stay the course.