submitted by
Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
With consumers making up 2/3rds of the U.S. economy, they have a large sway over the macroeconomy trajectory. Over the past year, for example, economic growth remained strong largely due to consumer spending. Making up one of four components of GDP (gross domestic product), along with investment, government spending, and net exports, it was consumption that drove the strong economic growth of the past year. Given the outsized role and the contributions to last year’s growth, consumers will have a large say in what happens to the economic landscape over 2025.
In a nutshell, signs are beginning to point to some hesitation. Both soft and hard economic indicators show that consumers may balk.
Coming out of the pandemic, a combination of government stimulus and supply shortages caused inflation to accelerate to a 40-year high. Consumer sentiment plummeted as a result, reaching historical lows. In fact, consumer sentiment was even lower than levels associated with prior recessions, but the U.S. escaped any recession. As inflation decelerated, consumer moods were improving, and sentiment began an upward climb. Consumer confidence, another measure that is tilted more toward the effects of the labor market, also was down, but with the strong job market, levels were not at historically low levels.
Following the election, optimism, as measured by both consumer confidence and sentiment, surged. It was not just consumers. Small business optimism had one of the largest spikes in the history of the series. The last time a similar spike had been observed was after the 2016 presidential election.
Then uncertainty emerged, kryptonite to markets and the economy. Administration messages of tariffs on and tariffs off. Tariffs up, and tariffs down. Carve-outs and exemptions. The off-and-on-and-ups and downs introduce something called risk. Throw in more risk, especially risk that was not necessarily anticipated, and this will serve as the killer to any stock market. Higher risk means lower asset values, and the NASDAQ moved into correction territory. Just like that, trillions of value destroyed. And capital likes to flow to the highest rate of return, other things equal, and the result is an exodus of capital from the USA. A recent fund manager survey showed the biggest drop in US equity allocation on record, with the US showing the largest decline and the Eurozone showing the largest gain in equity allocations.
What does this have to do with the economy and the consumer? As we’ve written in the past, two of the main reasons for consumer resiliency were the labor market and household net worth, driven by a combination of home values and equity investments, i.e., the stock market. Corrections have happened in the past and are part of historical stock market patterns, but investment behavior is also influenced by expectations, and the current level of uncertainty, along with stock market declines and volatility, were not exactly expected.
We see the impact of uncertainty on consumer activity here in Louisville Metro. Examining foot traffic for seven consumer-related industries, restaurants, shopping centers, home improvement, theaters and music venues, hobbies, gifts and crafts, hotels and casinos, and clothing, we see a stark change in behavior from early December (when expectations were running high) to late February. In early December, five out of the seven industries were running above trend with foot traffic, compared to the year before. The latest data show that six of seven are now running below trend, with negative changes compared to the previous year. Only hobbies, gifts, and crafts are just slightly above trend. Puzzles anyone?
Other spinoffs of uncertainty. In the latest NFIB survey, only 12% of owners reported it was a good time to expand their business. This was down 5 points from the previous survey, and was the largest decline since April 2020, during the height of the Covid recession. And only 37% of the respondents expect the economy to improve, down 10 points from the previous month. All this is the product of uncertainty, as the uncertainty index rose another four points, the second highest level of uncertainty since the early 90s. With uncertainty, small business owners are less likely to take risks, seek financing, or commit to major capital investment. This will act as a squeeze on the economy, contributing to a slowdown in overall growth. The latest Atlanta Fed GDP Now estimate of GDP for the first quarter is a minus 1.8%. A big driver of this is the surge in imports due to the threat of tariffs. But negative is negative, and that’s where the latest estimate stands. If this holds, it will be the first negative change in GDP since the first quarter of 2022, and who knows, maybe one of the fastest pivots in the economy, from U.S. exceptionalism to a self-inflicted slowdown.
