Catch-22 Economics: Confidence Falls as Growth Contracts

Source: http://www.flickr.com/photos/lsuchick142/

Where consumers go, the economy follows, and in the first quarter consumers really didn’t go anywhere. The Bureau of Economic Analysis reported this week that personal consumption expenditures increased just 0.7 percent between January and March, well below the previous estimate of 2.1 percent growth. The downward revision helped push the final GDP growth estimate down to minus 2.9 percent from minus 1 percent previously. This is the most severe economic contraction since the financial crisis.

Setting up a perfect catch-22 situation, lukewarm consumer spending may be driving down consumer confidence in the economy. Last week, Gallup’s U.S. Economic Confidence Index (ECI) fell to its lowest level since December.

It makes sense to establish at the beginning that consumer confidence surveys can be subjective and can sometimes be driven by what gets excessively written or heard in the media. But the ECI has an indicative value, since these surveys reach out to households to get a sense of what consumers are feeling about their economic situations. If people feel good about the economy and their standard of living in general, chances are they may have a propensity to spend more. But if they are not confident about the economy in the near future, they may be cautious in spending.

The U.S. economy is consumption driven — personal consumption expenditures account for nearly 70 percent of gross domestic product. This is why consumer sentiment readings have become an important indicator of how the economy is likely to do in the near future.

Gallup’s U.S. ECI dropped to minus 16 last week, its lowest reading since April. The ECI has moved in a tight range between minus 13 and minus 18 between March and June. This index is based on consumers’ views about two components: current conditions in the economy and the economic outlook. The range for the index lies between 100 to minus 100; that is, if all respondents thought the economy was doing well, the rating would be a 100, and if all of them thought it wasn’t doing that well, the rating would be minus 100.

According to the survey, about one in five Americans (22 percent) say the economy is “excellent” or “good,” while 34 percent say it is “poor.” From the consumers’ point of view, the economic outlook remains bleak, as 38 percent have said that the economy is improving, while 58 percent said it is getting worse.

The risk of rising oil prices may have helped weaken economic sentiment, given the tensions in Iraq. On June 13, the International Energy Agency said that violence in Iraq is the biggest risk to the oil supply this decade from any nation in the Organization of Petroleum Exporting Countries. And according to Bloomberg data, prices of Brent crude reached a nine-month high of $115.71 per barrel on June 19. Per IEA data, the U.S. imported about 9 million barrels of crude oil and related products from Iraq in March this year. Rising oil prices can quickly transpose into an inflationary risk, since it increases input and transportation costs and may get passed on to the consumers.

More From Wall St. Cheat Sheet: