Gloomy consumers, hawkish Fed: the price of defending the anchor

American households have rarely felt worse about the economy, and the Federal Reserve is weighing whether to raise interest rates. The pairing looks contradictory. It is not.

The University of Michigan's consumer-sentiment index slipped to 47.8 in early September, its weakest since the record low of 44.8 set in May and well below the 51 that forecasters had pencilled in. The composition is the telling part. The sub-index of expectations—households' view of the coming year or so—collapsed by 11% in a month to 45.8, and it is there that the damage concentrates. Consumers are not miserable because they are losing work; the labour market is, if anything, strong. Employers added 162,000 jobs in August, nearly three times what was forecast, and unemployment held at 4.1%. The grievance is prices, not pay packets. Americans feel a resurgence in petrol prices and trade tensions, and they expect more of the same: the survey's one-year inflation expectations jumped from 4.0% to 4.6%, above any reading in 2024, while its five-year measure edged up to 3.4%. Joanne Hsu, who runs the survey, says households anticipate "greater pressures on their pocketbooks to come."

This is a full-employment misery, and it matters for one reason in particular. Consumer sentiment is, at bottom, a poll: historically a weak predictor of both spending and the direction of markets. The number that actually moves portfolios is the inflation-expectations one, because that is what drives the central bank. And here the survey is moving the wrong way for anyone hoping for relief.

The anchor

A slumping consumer is normally an argument for easing. The familiar script runs from worried households to softer demand to rate cuts meant to revive them. This time the script is inverted. The Fed meets on September 15th-16th, and futures markets price roughly a 60% chance of a quarter-point rise. In July the Federal Open Market Committee held rates at 3.50-3.75% by a 9-3 vote, with the three dissenters—Beth Hammack, Neel Kashkari and Lorie Logan—wanting a hike there and then. Inflation has now sat above the Fed's 2% target for five years; the three-month annualised rate of the core personal-consumption-expenditures index is just over 3%. Kevin Warsh, the new chairman, has noted that 54% of the measure's components rose by more than 3% over the past year. A hiring surge of 162,000 jobs challenges the administration's claim that a supply-side boom can keep growth and inflation apart.

Against that stands a loud demand to cut. President Donald Trump, his vice-president, the Treasury secretary and the trade adviser Pedro Navarro—who called a rise "careless" and FOMC members "clowns"—are pressing Warsh to loosen policy; Trump has threatened to halt trade with countries running surpluses with America unless rates fall. The Michigan report hands the hawks the ammunition that matters: its long-run inflation measure, drifting at 3.4%, now sits above the 2.8-3.2% band it occupied through 2024. The rise is a fraction of a point and the gauge is noisier than market-based ones, but at the moment of decision it is pointing in the wrong direction. It is the anchor the Fed exists to defend, and it is shifting.

Misery is not a buy signal

The trap for the ordinary investor is to read all this as a reason to buy. Record-low sentiment reads like recession, and recession reads like cuts, and cuts read like lower discount rates and higher multiples. Each step is comfortable and each is contestable. The poll itself is deep in recession territory—its long-run average since 1952 is 84.3—yet the labour market says nothing of the sort. And even if the Fed holds rather than hikes, real rates stay high and long-duration growth stocks stay under pressure. The genuine sources of consumer pain, energy and tariffs, squeeze corporate margins from the top and household budgets from the bottom, falling hardest on lower- and middle-income Americans who feel petrol prices every week.

The choice before Warsh is between costs, not between good and bad. Cut to soothe a miserable electorate and an importunate president, and the forward expectations that keep 2% plausible begin to slide. Hike to defend the anchor, and the gap between what households feel and what the jobs report says widens further. For investors the lesson is the deflation of a comforting narrative: consumer misery is not automatically a buy signal, because this time the central bank's binding constraint is credibility, not compassion. Whether it surrenders to the White House may prove the more consequential variable for the path of rates, and hence of equities.