Consumer Sentiment and Inflation Expectations as Leading Indicators of Market Volatility

The U.S. economy is navigating a precarious tightrope in 2025, with consumer sentiment indices and inflation expectations serving as early warning signals for market turbulence. The Conference Board’s Consumer Confidence Index (CCI) fell to 97.4 in August 2025, a 1.3-point decline from July, while the University of Michigan’s Consumer Sentiment Index (MSCI) dropped 5.7% month-over-month to 58.2 [1][2]. These metrics, historically reliable barometers of economic health, now reflect a duality: cautious optimism about business conditions coexists with pessimism about personal financial prospects [3]. Meanwhile, inflation expectations, as measured by the New York Fed’s Survey of Consumer Expectations, rose to 3.1% for the one-year-ahead horizon in July 2025, up from 3.0% in June [4].

The interplay between these indicators and market volatility is becoming increasingly pronounced. Tariff-driven uncertainties and policy hesitancy have amplified investor fears of stagflation, causing sharp swings in equity markets [5]. For instance, the CCI’s Expectations Index, at 74.8 in August, remained below the 80 threshold—a level historically associated with recessions—while 26.8% of consumers anticipated fewer jobs in the coming months [1]. This labor market pessimism, combined with rising inflation perceptions, has eroded confidence in durable goods spending, a key driver of cyclical sectors like automotive and housing [3].

Strategic asset reallocation is now imperative. Cyclical equities, particularly those tied to discretionary consumer spending, face headwinds as households prioritize savings over consumption. The Conference Board notes that infrastructure and housing have gained importance, but these sectors remain vulnerable to policy shifts and material cost pressures [3]. Conversely, defensive equities—such as utilities, healthcare, and consumer staples—are better positioned to weather the storm. These sectors have historically outperformed during periods of high inflation and low consumer confidence, as they offer stable cash flows and essential services [6].

Inflation-linked assets also warrant consideration. Treasury Inflation-Protected Securities (TIPS) and real estate investment trusts (REITs) have demonstrated resilience amid rising price pressures. Energy stocks, too, have shown a unique ability to hedge against inflation, as their cash flows tend to rise with commodity prices [7]. For investors, the challenge lies in balancing exposure to these defensive and inflation-linked assets while maintaining liquidity to capitalize on potential rebounds in cyclical sectors.

The Federal Reserve’s delayed easing cycle further complicates the landscape. Despite signs of a softening labor market, policymakers have hesitated to cut rates, prolonging uncertainty and exacerbating volatility [5]. This policy lag underscores the need for dynamic portfolio adjustments, with a focus on sectors insulated from interest rate fluctuations and inflationary shocks.

In conclusion, the confluence of deteriorating consumer sentiment and sticky inflation expectations signals a shift toward risk-off strategies. Investors must recalibrate their allocations to prioritize defensive equities, inflation-linked assets, and sectors with pricing power. As the economy grapples with the dual threats of stagflation and policy inertia, agility and foresight will be critical to navigating the turbulence ahead.

Source:
[1] US Consumer Confidence [https://www.conference-board.org/topics/consumer-confidence/]
[2] of Consumer Sentiment - University of Michigan [https://www.sca.isr.umich.edu/]
[3] A Strategic Shift Toward Construction and Engineering [https://www.ainvest.com/news/consumer-confidence-surpasses-expectations-august-strategic-shift-construction-engineering-2508/]
[4] Survey of Consumer Expectations [https://www.newyorkfed.org/microeconomics/sce]
[5] Market Volatility in 2025: Tariffs, Inflation and the Consumer Impact [https://www.diamond-hill.com/insights/a-780/articles/market-volatility-in-2025-tariffs-inflation-and-the-consumer-impact/]
[6] Inflation risk and stock returns: Evidence from US [https://www.sciencedirect.com/science/article/abs/pii/S1062940823001092]
[7] Economic outlook: Third quarter 2025 [https://www.fidelity.com/viewpoints/market-and-economic-insights/quarterly-market-update]