A turbulent stock market in recent weeks has led to a deterioration in consumer sentiment, as Americans grow more concerned about equity performance and the economy’s trajectory.

According to the University of Michigan’s latest consumer survey, sentiment declined 6% in October. This drop was driven largely by high-income households and those with significant stock investments, matching the weakness seen in equity markets this month.

The benchmark S&P 500 index has pulled back from its peak in July, with investors made uneasy by resilient economic data and fears of prolonged interest rate hikes by the Federal Reserve. Surging Treasury yields, with the 10-year approaching 5%, have compounded equity volatility.

Big Tech Disappoints, Dragging Nasdaq Into Correction Territory

Third-quarter earnings reports from major technology companies, which hold substantial weight in stock market indexes, have proven disappointing for investors. Amazon, Meta, Microsoft and Alphabet all reported robust earnings but highlighted areas of weakness.

On Thursday, the tech-heavy Nasdaq index tilted into correction territory, dropping over 10% from its high, as shares of Apple, Amazon, Nvidia, Microsoft and Alphabet declined. These five companies alone comprise nearly 25% of the total value of the S&P 500. Their performance significantly sways broader market sentiment.

With third-quarter results still underway, investors remain anxious that further disappointments from big tech could spur a deeper market pullback. The Fed’s tightening policies also continue to create headwinds.

Inflation Expectations Climb, Stoking Fear of Persistently High Prices

Alongside stock market turbulence, rising inflation expectations are impacting consumer morale. Survey respondents predict inflation of 4.2% over the next 12 months, up sharply from 3.2% in September.

This is the highest one-year inflation expectation recorded since May 2022. Forecasts for inflation over the next 5-10 years also edged up to 3%, higher than September’s 2.8% figure.

If expectations become entrenched that inflation will not moderate over time, it risks leading to a self-fulfilling prophecy of permanently higher prices. This would make it exponentially harder for the Federal Reserve to steer inflation back to its 2% target.

The Fed monitors inflation outlooks closely when shaping monetary policy. Climbing expectations build pressure for more aggressive interest rate hikes aimed at taming inflation.

Consumers Prioritize Savings, Curb Spending Amid Gloomy Outlook

With sentiment deteriorating, consumers are increasingly prioritizing savings over spending. The Michigan survey showed a significant decline in buying attitudes for homes, cars and other large purchases.

Households are also moderating discretionary spending and non-essential consumption to shore up their finances. This marks a notable shift from robust spending patterns earlier in 2022 when pandemic savings were still flush.

Economists believe higher borrowing costs will weigh on big-ticket purchases moving forward. Mortgage rates are approaching 7%, denting the affordability of home buying. Moreover, credit card rates have risen in tandem with the Fed’s benchmark rate.

A pullback in consumer outlays, which drive over two-thirds of US economic activity, points to weakened growth prospects. It may also help cool demand and ease price pressures, supporting the Fed’s inflation fight.

Federal Reserve Faces Critical Policy Dilemma

For the US central bank, conflicting economic signals complicate policymaking. Strong job gains and consumer demand work against their inflation battle. But market stress and waning sentiment give pause on the pace of rate increases.

Another 75 basis point hike is expected at the November meeting. But the Fed must weigh overtightening and spurring an economic contraction.

With risks tilting to the downside, some economists predict the terminal rate may not need to rise as high as 5%. But moderating inflation sustainably remains the priority.

Ongoing geopolitical tensions, supply uncertainties, and global slowdown also impact the policy path. Careful calibration is required to achieve a soft landing.

Investors currently foresee rates peaking under 5% in 2023, followed by modest cuts. But the roadmap remains unclear. Hawkish messaging persists for now.

Outlook Hinges on Inflation Trajectory into 2023

Despite recent stock market turmoil and weaker sentiment, the US economy has proven surprisingly resilient so far. The labor market remains robust and spending is moderating gradually from lofty levels.

But the outlook rests critically on whether inflation continues descending from its 40-year highs. Global factors like the Russia-Ukraine war and China’s zero-covid policy significantly influence commodity and supply chain dynamics.

If price pressures ease over the next few months, the Fed may be able to chart a more balanced policy course. This would provide some reprieve for battered markets and anxious consumers.

But entrenched inflation expectations pose a major risk. With monetary tightening still in early stages, the Road ahead remains bumpy. Savvy Americans may take the market unease as a sign to review their finances, lock in rates for large purchases, and build emergency savings.

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