Why are we so glum?

Despite some recent volatility, markets are starting to look optimistically at the potential for a soft landing – inflation is falling towards a normalized level, unemployment is up, but still at historically low levels, and the Federal Reserve looks set to embark on a rate-cut cycle. Yet with all this positive data, many people are still negative. RealClearPolling’s average of polls shows that nearly two-thirds of Americans believe the country is on the wrong track. We think there are four main reasons why consumers’ perceptions don’t necessarily meet up with the data.

Housing affordability One of the reasons for the poor confidence could be housing affordability.  In 2022, the Fed began a massive rate-hiking cycle to combat inflation, increasing rates by 5.5% over just 18 months. With this, the average interest rate for a 30-year mortgage went from 2.82% in February 2021 to 6.90 % on August 19. That means that a buyer who is taking out a loan for a $250,000 house would pay a total of $617 more per month than just two years ago ($222,120 over the life of the loan). This has caused first-time home buyers to feel like housing is out of their reach and has locked existing homeowners into their mortgages, unable to trade up to a different property. Existing home sales have plummeted to an annual rate of 3.89 million units, their lowest level since the Housing Crash in 2008.

Inflation not far removed Headline inflation data for the month of July reported a month-over-month increase of 0.2% and a year-over-year rate of 2.9%. While this is still high, it is clearly gliding towards the Fed’s target of 2.0%. However, looking backwards, the data is not as rosy. I frequently hear from consumers about how they remember paying lower prices just a few short years ago. In fact, if we look at the rate of change of inflation over the trailing three years, instead of the trailing one year, we find that inflation is running at 15.3%, its highest level since 1990. While the current situation is improving, it will likely take time for consumers to adjust to the new prices.

Real earnings flat While average hourly earnings – a measure of wage growth - grew as fast as 5.9% in 2022, most of these increases have been offset by inflation. In fact, real earnings fell on a year over year basis from April 2021 to April 2023 and are just now returning to levels seen in January 2022. While that means that a consumer’s situation is not worse off than what it was, it could be an explanation for why they are feeling so sour. Even if nominal wage gains mean inflation has not actually moved them backwards, I suspect most employees, understandably enough, are dismayed to see inflation eat away their hard-earned wage increases.

Things were better before Covid The misery index is a concept devised in the stagflationary 1970s. It adds together the inflation rate and the unemployment rate to create a quick measure of the “misery” facing the ordinary person. Now that inflation has come most of the way down, the misery index is quite low, at some of the lowest levels of the last 50 years. But it was even lower from late 2014 until early 2020 when Covid hit.  

If inflation continues to retreat and the economy stays strong, it’s hard to think that the sourness manifested in the right track versus wrong track polling can last forever. Interest rates would likely be lower, helping the housing market improve. The inflation spike of 2022-23 would recede further into the background. Productivity gains (which have been strong lately) could help real wages turn upward. If all that happens, maybe people will start to think that things are OK nowadays too.