Trade Policy Uncertainty and the Gathering Storm of Consumer Pessimism

The May 2025 University of Michigan Consumer Sentiment report delivers a stark warning: U.S. households are bracing for a perfect storm of inflation, job market fragility, and trade-related economic uncertainty. With year-ahead inflation expectations surging to a 44-year high of 7.3% and labor market confidence plummeting to levels last seen in the early 1980s, the data underscores a deepening crisis of confidence that could accelerate the economy's slide toward recession.

The Inflation-Labor Market Feedback Loop

The report's most alarming takeaway is the self-reinforcing cycle now gripping households. Rising inflation expectations—driven by unresolved trade disputes and stagnant wages—are eroding consumer spending power, while deteriorating labor market confidence is further dampening income growth. This dynamic creates a double-edged sword: households, anticipating higher prices and fewer jobs, cut discretionary spending, which risks slowing economic activity and pushing unemployment higher.

Take the labor market metrics: Two-thirds of consumers now expect rising unemployment in the year ahead, the highest level since the 2009 financial crisis. Meanwhile, assessments of personal finances fell by nearly 10% in May, with incomes failing to keep pace with inflation. These trends are already reflected in the expectations index, which hit 46.5—the lowest since May 造1980—signaling a loss of faith in future economic conditions.

Trade Policy: The Catalyst, Not Just a Headwind

While inflation and labor markets are the immediate concerns, the root cause of this pessimism is clear: trade policy uncertainty. Nearly three-quarters of consumers spontaneously cited tariffs on Chinese imports as a top economic worry—a 17% increase from April. Even temporary tariff pauses, such as the April 9 partial reversal, failed to meaningfully improve sentiment. This suggests businesses and households now view trade tensions as a persistent structural risk, not a temporary blip.

The implications for Federal Reserve policy are profound. The Fed faces an impossible choice: Cut rates to support a weakening economy, risking a further climb in inflation expectations, or hold rates steady to anchor prices, thereby exacerbating recession risks. The May data makes it clear: Neither path offers a clear escape.

Positioning for a Volatile Landscape

Investors must act decisively to protect portfolios from the twin threats of recession and inflation. The Michigan report's final reading of 52.2—barely revised up from the preliminary 50.8—leaves little room for optimism. Here's how to navigate this environment:

1. Defensive Assets First:
2. U.S. Treasuries: With recession risks rising, demand for safe-haven assets like the 10-year Treasury will likely outpace even the Fed's ability to influence yields.

3. Utilities and REITs: These sectors, with their stable cash flows and low sensitivity to economic cycles, offer ballast in turbulent markets.

4. Short Cyclical Equities:

5. Industrials and Consumer Discretionary Stocks: These sectors are disproportionately exposed to both inflation and labor market weakness. The S&P 500 Industrials index has already underperformed the broader market by 12% year-to-date, a trend likely to accelerate.

6. Monitor the Fed's Dilemma:
   Investors should brace for a “lower-for-longer” interest rate environment. Even if the Fed pauses hikes, the inflation-labor market dynamic will limit its ability to stimulate growth without igniting prices.

Conclusion: The Time for Caution is Now

The May Michigan data is a flashing red light for investors. With consumer sentiment near record lows and trade policy uncertainty eroding confidence, the path to recession is now alarmingly clear. Defensive assets are not just a hedge—they are the core of a prudent strategy. Cyclical bets, meanwhile, carry outsized risks as households retrench.

The writing is on the wall: Prepare for prolonged economic volatility, and act before the storm fully breaks.