In a Sentimental Mood
Measuring the Economy Through Consumer Sentiment
How do you feel about the economy? The question sounds simple. The answer rarely is. Depending on whom you ask, you might get more than you bargained for. Yet, researchers at the University of Michigan have been asking it every month since 1940, despite the strong emotions this question can elicit. They survey close to 1,000 individuals, asking five core questions about their personal finances, expected future conditions, and attitudes toward major purchases. The responses are tabulated and distilled into one of the most publicized numbers in economics: the University of Michigan’s monthly Index of Consumer Sentiment. For decades, investors have used the index as a compass for potential future economic growth. But in May, the Federal Reserve cautioned that such a strategy could take one off course.
Unlike most economic indicators that are broadly accepted and rarely debated (GDP, interest rates, inflation, etc.), consumer sentiment is different. It’s emblematic – a singular data point that represents something larger. That’s why the question “How do you feel about the economy?” seldom yields the same answer.
Investors’ interest in consumer sentiment is understandable. While most economic indicators reflect what has happened, consumer sentiment measures what people expect to happen. It’s the undercurrent of nearly every economic decision: whether to spend, save, invest, or hold back. On Wall Street, it is a question of being “bullish” or “bearish.” On Main Street, it’s simpler: are you confident, or concerned?
Until recently, the link between consumer sentiment and future economic growth has been well accepted. The thinking was that when consumers feel upbeat, they tend to spend and invest. When confidence wanes, spending slows. And when spending slows, so can future economic growth. However, the past five months have led some (including those at the Federal Reserve) to question if changes in consumer sentiment have any relation to changes in the broader economy.
The chart below shows the monthly change in consumer sentiment from 1985 through May 2025.
Much like a thermostat, consumer sentiment measures the temperature of the room, or in this case, the nation. It reflects how we feel collectively about the state of the economy. Look closely and the chart reads like a national diary: confidence plunging after Iraq’s invasion of Kuwait in 1990; unraveling during the 2007–2009 financial crisis known as the Great Recession; collapsing again in the early days of the COVID-19 pandemic. And then there are those moments that at the time felt seismic, but in retrospect, were relatively insignificant.
Over the past five months, consumer sentiment has declined, while the stock market and economy have continued to show signs of strength. This has fueled debate not only about the future strength of the U.S. economy, but also whether consumer sentiment is a useful tool for forecasting economic growth and stock market performance.
The recent decline in sentiment is attributed to the administration’s tariff policy and international events. Another factor, though rarely discussed, is particularly timely: the Economic Policy Uncertainty Index for the United States. This arcane index, which attempts to quantify economic uncertainty, has become increasingly volatile in recent months, hitting four all-time highs since January. While the mechanics of measuring economic policy uncertainty can be subjective, the recent trend suggests a growing sense of unease.
If we look beyond the short-term swings in sentiment, a clear trend emerges. Since 1985, the Consumer Sentiment Index has shown a subtle but persistent decline. Sentiment has decreased an average of 0.59 points per year, despite periods of economic expansion and record market performance. Richard Curtin, Director of the University of Michigan’s Survey of Consumers from 1976 to 2021, has suggested that long-term sentiment erosion may stem from rising inequality, institutional distrust, and growing political polarization. We would suggest that the change in the way we consume news – through curated, often polarized media streams – may be the culprit, amplifying biases and reinforcing subjective economic narratives.
The chart also illustrates the volatility of the index, which makes forecasting economic growth difficult. Not all declines lead to a slowdown in the economy, as consumer confidence can rebound quickly. While consumer sentiment has fallen from January to May, reaching 52.2 in May, economists are unsure if this will lead to a slowdown in the economy. This has left investors to wonder if this is just another minor “dip,” or a harbinger of something worse. Yet, what the chart does indicate is that when confidence collapses, it tends to do so with remarkable speed. The climb back? That’s another story.
In behavioral finance, a slow recovery from negative events is attributed to loss aversion – bad news simply cuts deeper than good. Economists call it hysteresis – a technical term that in this case represents something deeply human: the long memory of fear. To illustrate how long it takes to recover from a sharp drop in sentiment, we analyzed several large economic shocks and their subsequent declines in consumer sentiment.
Not all shocks lead to prolonged recoveries. Take the invasion of Kuwait, for example - what mattered most was not the severity of the event itself, but the speed at which consumer fears were reversed. The panic passed quickly, and sentiment stabilized. More recently, the aggressive response by the Federal Reserve and the Treasury Department to the COVID-19 pandemic certainly played a role in the shortened duration of lowered consumer confidence.
The most recent decline in consumer sentiment has led to stories of consumers feeling unsure about the future. However, if we dig a little deeper, we can see a sharp contrast in the level of confidence between Democrats and Republicans. In late April, The Wall Street Journal published a piece titled “Consumers Serve Up a Bleak Outlook for the Economy,” citing a Gallup poll and research by Joanne Hsu, whose study Partisan Perceptions and Sentiment Measurement was published through the University of Michigan’s Survey of Consumers.
Hsu’s research confirmed an old truth: if your party holds the White House, you’re more likely to feel optimistic about the economy. If not, skepticism tends to settle in. And like the weather, it shifts depending on who’s in the Oval Office.
The above chart illustrates how consumer sentiment aligns with political affiliation. The shift in consumer sentiment between Democrats and Republicans after an election can be dramatic. Hsu’s research confirmed what behavioral economists have long observed: we are not always rational, objective “weighing machines.” When our political team is in charge, we feel confident. When it’s not, we brace for impact, even when actual conditions remain unchanged. Democrats rated the economy more favorably under Democratic presidents; Republicans did the same under Republican presidents. Research from the University of Michigan and the Pew Research Center confirms this pattern: partisan bias now accounts for a significant portion of the difference in consumer sentiment scores.
It’s worth asking: as politics has become more divisive, has this caused the stock market to be more volatile? The short answer is that in certain circumstances, it has. A Federal Reserve Bank study, using a Partisan Conflict Index, showed that increases in political disagreement are associated with heightened market uncertainty and volatility.
For investors, the recent decline in consumer sentiment challenges how useful the index can be for predicting the health of the economy. Despite consumers’ less-than-cheerful mood, the economy has continued humming along. In May, the Federal Reserve urged caution in relying on the index for economic forecasts, noting that sentiment data have not substantially improved predictions of consumer spending growth beyond what official data already indicate. As Chair Jerome Powell remarked, “The link between sentiment data and consumer spending has been weak.” The recent decline in consumer sentiment has not been enough for the Fed to act, but rather to “wait and see” whether other economic indicators show signs of weakness. So far, they have not.
Powell’s opinion is warranted; the continued strength of the U.S. economy challenges the decline in consumer sentiment. However, what he did not mention is the “duration of the decline.” While short-term movements in the Index may have little impact on economic growth, a longer decline may tell another story. This is why future reports will be watched by investors eager to determine whether the decline in consumer sentiment continues or was just an aberration. Regardless of the outcome, one thing is certain: the Index will continue to draw attention, spark debate, and fuel discussion. Yet, it isn’t just a number. It’s 1,000 voices. It reflects a national mood that surfaces in dinner table conversations and opinion page essays. A mood that doesn’t merely describe the present, but hints – often imperfectly – at what may come next. It is where each month the opinions on Main Street trumps those on Wall Street. And each month it begins with a simple question: How do you feel about the economy?
Disclaimer: The information provided is subject to change. As always, the information provided is for entertainment purposes only and not intended as financial, investment or legal advice. Listeners, or readers, should not rely on the information provided for making financial, investment, or legal decisions. Always consult with a professional before making any financial, investment, or legal decisions.