By Sabrina Escobar

Americans are feeling increasingly anxious about the economy as food prices stay high and policy changes spark worries about continued inflation. Negative sentiment eventually could translate to a pullback in spending.

The University of Michigan's consumer sentiment index surprised to the downside in February, coming in at 64.7. Economists were expecting the index to tick down to 67.5 from the preliminary reading of 67.8, according to FactSet.

The latest sentiment reading, reported Friday, reflected a substantial drop from December's reading of 74, and January's reading of 71.1. It followed Walmart's issuance Thursday of disappointing financial guidance for the fiscal year ending in January 2026. Both reports rattled investors, and helped to send the S&P 500 down more than 100 points, or 1.7%, in Friday's trading.

The downturn in consumer sentiment could have troubling repercussions for the economy. Consumers often spend more when they feel better about the financial outlook, and retrench in times of uncertainty. For many Americans, the Trump administration's recent policy changes have heightened uncertainties about the economic outlook. While the changes in the sentiment survey were unanimous across age, income, and wealth demographics, the dissatisfaction reflected a split by political affiliation: Democrats and independents were more likely to have reported a negative change in sentiment, while Republicans' sentiment was largely unchanged.

Undergirding the pessimism were concerns about how President Donald Trump's policies -- particularly tariffs -- will affect the economy. Survey results suggest Democrats and independents believe the policies could reignite inflation, while Republicans think they will help prices drop.

February's median inflation expectation for the year ahead spiked a full percentage point, to 4.3%, from January's 3.3%. That marked the highest reading since November 2023. Long-term inflation expectations also increased, rising to 3.5% in February from 3.2% in January, the largest monthly increase since 2021.

The Federal Reserve has targeted annual inflation of 2%, although recent inflation readings suggest price growth is stuck well above 2%.

It doesn't help sentiment that costs for daily purchases, including food and gasoline, have increased over the past few weeks. Avian influenza and national disasters such as the California wildfires have crimped food production, leading to a surge in prices.

Worries about inflation already look to be dissuading Americans from splurging. The index measuring expectations for buying conditions for durable goods plunged 19% in February, in large part "due to fears that tariff-induced price increases are imminent," said Joanne Hsu, director of consumer surveys at the University of Michigan.

January retail sales fell 0.9% from December levels, while existing-home sales fell 4.9% month over month -- marking the slowest month since October.

"With falling consumer sentiment and mortgage rates still close to 7%, housing demand is likely to stay constrained in the near term," wrote Citi economist Alice Zheng in a note Friday.

Eugenio Alemán, chief economist at Raymond James, is more upbeat, positing that the surge in inflation expectations is temporary.

"We believe concerns about tariffs may be exaggerated," he wrote on Friday. "President Trump is likely using the threat of tariffs as a strategic tool to bring countries to the negotiating table. Once fears about tariffs fade, inflation expectations will likely come down."

Still, he acknowledged that in the short term, the spike in consumers' inflation expectations presents another "bump on the road" for the Fed's campaign to lower interest rates. Policymakers have said consumers' well-anchored inflation expectations are part of the reason they are forecasting that inflation will recede without a recession.

In the futures market, traders have put 95.5% odds on the Fed holding the federal funds rate steady at its March policy meeting, at the current target range of 4.25%-4.50%, according to the CME FedWatch Tool. Odds of a quarter-point rate cut at the May meeting have risen, however, to 28% from 22.2% on Feb. 20 and 18.5% on Feb. 14, suggesting fears the economy may start to weaken.

Investors will learn more about consumers' health and spending habits in coming weeks, as other large retailers post fiscal fourth-quarter results. The preliminary Michigan Consumer Sentiment reading will be published March 14.

Write to Sabrina Escobar at sabrina.escobar@barrons.com

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February 22, 2025 01:00 ET (06:00 GMT)

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