WHAT IS CONSUMER SENTIMENT?
The information is subsequently visually displayed (refer to the diagram below) illustrating periods of economic decline (indicated in grey) in relation to the ICS – consumer sentiment, which can indicate potential upcoming recessions. In simple terms, a higher sentiment value suggests increased consumer confidence in their economic circumstances (and conversely).
The populace outlook indicator is frequently regarded as a preeminent forecaster as dwindling consumer statistics consistently come before economic downturns.
Consumer sentiment, consumer confidence, or the Index of Consumer Sentiment (ICS) serves as a gauge for the general economic well-being according to consumer input. The measurement encompasses public perceptions from surveys covering past, present, and future economic outlooks regarding personal finances and the overall economy. The report presents data similar to the economic calendar provided below and also includes information on inflationary expectations.
Distinctly, economic surveyors have conventionally engaged consumers, presenting them with inquiries akin to the current set of questions displayed below. These questions aim to elicit opinions from consumers about their sentiments concerning their financial situation.
The consumer sentiment survey in the U.S. was originated by Dr. George Katona from the University of Michigan and was first employed in 1946. It focuses on the emotional state of consumers rather than relying solely on quantitative metrics, thus earning the moniker 'Michigan Consumer Sentiment.' The underlying objective of this survey is to comprehend how individuals make economic decisions, thereby facilitating better management of the country's policies. The questions provided are designed to be timeless, proving suitable for both individuals in the 1960s and the contemporary era.
GUIDE TO COMPREHEND THE CONSUMER SENTIMENT INDEX:
Understanding the consumer sentiment index is straightforward and accessible to the general public. The survey findings are gathered and processed to generate various readings presented in the report. The Index of Consumer Sentiment (ICS) is calculated using the formula illustrated in the image below. While constituent formulas may vary, this article will concentrate on the primary print and formula.
The information is subsequently visually displayed (refer to the diagram below) illustrating periods of economic decline (indicated in grey) in relation to the ICS – consumer sentiment, which can indicate potential upcoming recessions. In simple terms, a higher sentiment value suggests increased consumer confidence in their economic circumstances (and conversely).
The populace outlook indicator is frequently regarded as a preeminent forecaster as dwindling consumer statistics consistently come before economic downturns.
CONSUMER SENTIMENT AND ITS RELATIONSHIPS WITH INFLATION
Consumer perception and its connection with inflationary pressures can evoke apprehension among individuals, as evidenced in the comparative data from 2020 to 2022. The escalation of prices coincides with a decline in consumer sentiment, leading to concerns about a potential economic downturn in financial markets. This chain reaction poses challenges for central banks, as the conventional approach of raising interest rates to combat inflation can further dampen consumer sentiment by increasing borrowing costs.
Effectively managing monetary and fiscal policies hinges on a comprehensive understanding of consumer behavior. For instance, when consumers hold the belief that inflation will persist, they tend to stockpile and purchase more goods now to avoid higher future prices. This, in turn, contributes to even higher inflation rates, underscoring the critical role of central banks in instilling consumer confidence by committing to reducing inflation. The communication style of central bank officials becomes paramount in persuading consumers toward the desired economic outcome.
HOW TO TRADE CONSUMER SENTIMENT
Michigan, consumer, sentiment, S&P500, index, DXY, 2017-2022
The aforementioned chart illustrates the correlation between U.S. consumer sentiment, the Dollar Index (DXY), and the SPX index. Now, let's delve into each aspect separately.
Regarding CONSUMER SENTIMENT IN THE STOCK MARKET, historical data suggests that there exists an inverse relationship between U.S. consumer sentiment and the SPX. When consumer sentiment experiences extreme drops, it often leads to substantial upswings in the S&P 500 index. This phenomenon is logical, as a fearful market environment provides opportunities for investors to take advantage of undervalued stocks. Conversely, in an overconfident market, larger institutional investors may become apprehensive, while greed-driven investors keep pouring in their funds, ultimately resulting in significant market declines when the tide turns.
To summarize, consumer sentiment can serve as a contrarian indicator for the U.S. stock market, especially during periods of considerable fluctuations. However, there may be exceptions to this rule depending on the prevailing context, where traditional economic principles might not always align perfectly.
CONSUMER SENTIMENT IMPACT ON FOREX MARKET:
The relationship between U.S. consumer sentiment and the U.S. dollar in the FX market is typically positive. The theory suggests that a drop in consumer sentiment prompts looser monetary policies to boost consumer spending on durable goods, resulting in lower interest rates that weaken the home currency (DXY), and vice versa. However, in 2022, this conventional correlation was disrupted due to a unique fundamental backdrop characterized by high inflation, recessionary fears, geopolitical instability, and declining consumer sentiment. Surprisingly, the Federal Reserve adopted an aggressive/hawkish stance to combat inflation despite falling consumer sentiment. This unusual scenario allowed the dollar to strengthen as it was perceived as a safe-haven currency and due to increased interest rates.
A SUMMARY OF CONSUMER SENTIMENT:
Consumer sentiment provides valuable insights into various fundamental aspects of an economy, offering a deeper understanding of financial markets. As a leading indicator, it can be a valuable trading tool for both fundamental and technical traders. At DailyFX, we regularly provide consumer sentiment overviews and interpret the data's implications for the markets. If you are uncertain about certain economic concepts, feel free to explore our trading education section to enhance your knowledge.
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Basis-of-Macroeconomics