The Fed Must Have Confident Consumers

I can’t help but feel like I’m reliving the 2007-2008 financial crisis as if it happened yesterday. In the days leading up to it, there was an endless stream of stories about the market freezing. People were defaulting on their home loans at an alarming rate. The banks’ balance sheets were swelling with assets that were rapidly losing value.

Initially, the major news outlets didn’t give much attention to this event. Consequently, people weren’t overly worried about it. During a family dinner conversation with my in-laws, I found they were surprised by the topic as it wasn’t widely covered in their regular news intake through TV or radio. Hence, it wasn’t something that stood out to them.

Within a year, the stories were everywhere. As the carnage built, consumers panicked. You see, most people have the bulk of their net worth tied up in the value of their homes. As that started to fall apart, consumer confidence plummeted. Americans felt their net worth declining and started to pull back on spending.

Current Federal Reserve officials have experienced this situation firsthand. Some, such as Neel Kashkari who serves as the President of the Minneapolis Fed, played significant roles during the bailout period. Others have contributed to restoring the financial system’s stability.

Over the course of the COVID-19 pandemic, many have held onto their positions. They understand the destructive impact that a drop in consumer trust can have on the economy. Therefore, they are determined to avoid such a scenario repeating itself. To achieve this, the Federal Reserve has initiated a series of interest rate cuts and is expected to continue easing for the foreseeable future. This move should provide a stable uptrend for high-risk assets such as cryptocurrencies.

But don’t take my word for it, let’s look at what the data’s telling us.

During the 2000s’ initial phase, the domestic real estate market experienced an intense boom. Interest rates were reduced significantly, making it simpler for individuals to obtain loans. Eager to increase their profits, banks found themselves ready and willing to provide these loans. They could then bundle these loans into mortgage-backed securities and enjoy substantial returns from the resulting profit margins.

Homeowners found themselves with increasing chances to obtain larger loans as property values continued to climb. Essentially, their homes served as a constant source of lending, much like an ATM. Banks were eagerly providing these loans, extending credit even to those with less-than-stellar credit histories, aiming to foster growth and expansion.

Consequently, all this lending resulted in increased spending, which caused the economy to become more active. Inflation climbed from 1.1% in mid-2002 to 3.3% by late 2004 as a result. Our central bank felt compelled to intervene. From July 2004 to the same month in 2006, they boosted the effective federal funds rate from 1% to 5.25%. All of a sudden, purchasing houses became less appealing.

People found themselves deeply in debt due to borrowing more money than they could possibly repay, using their homes as collateral. As house prices began to decrease, the amount they owed relative to the value of their properties significantly increased. Soon enough, homeowners discovered that surrendering their properties back to the bank was a less burdensome option compared to spending the remainder of their lives paying off the debt.

It was around this period that consumer confidence started showing a significant decline. Looking back at the initial graph, you’ll notice that, as per the University of Michigan’s index, consumer confidence reached its highest point in early 2007, standing at 96.9. At that time, interest rates for loans were relatively high and the housing market bubble was on the verge of bursting.

As people watched their savings decrease dramatically, consumer trust plummeted. This downward spiral didn’t stabilize until November of 2008 at a record low of 55.3. During this period, the economy suffered greatly. The Federal Reserve was slow to acknowledge the change and didn’t implement its first interest rate reduction until late in 2007, long after house prices had begun to decrease.

Ultimately, our central bank will lower interest rates to their lowest possible level, which is zero. Consumer trust would take another five years to recover significantly, and it would take an additional seven years for the Fed to consider raising rates once more.

Moving forward during the pandemic, events transpired in a familiar pattern. State and local authorities urged citizens to stay indoors for safety reasons. Schools and shopping centers shut down, while companies requested employees to work from home. Uncertainty loomed as nobody knew how long this situation would persist or what impact it might have on their earnings. As a result, consumer trust eroded.

In the graph you see, the University of Michigan’s consumer sentiment index reached 101 in February 2020. However, it dropped significantly to 71 just two months later. It wasn’t until about two years afterwards, in 2022, that individuals felt more equipped to handle post-pandemic life, which caused the consumer confidence index to dip down to roughly 50.

Once again, similar to the previous occasion, our central bank remained inactive until the crisis fully materialized. By April 2020, it reduced interest rates to zero and increased the scale of its balance sheet to infuse money into the financial system. The Fed aimed to encourage businesses and individuals to spend more. It was an attempt to build confidence.

So now, let’s look at what’s going on with consumer confidence today:

In my recent analysis, I’ve noticed a softening trend in consumer confidence, with the index dropping from its peak of 79 in March to 66 currently. This decline is noteworthy as it represents the most significant dip since June 2022. The likely culprit behind this shift seems to be rising interest rates. Given this trend, it’s safe to assume that the Federal Reserve has taken notice of the situation.

Experiencing a crisis leaves an indelible impact. It often represents a significant, transformative challenge in your life or that of someone near to you. This experience typically influences the choices you make, particularly with regard to finances, in the future.

To put it simply, many of the current leaders at our central bank experienced the pandemic and its aftermath of the financial crisis. As a result, their perspectives and decisions regarding monetary policy have been significantly influenced by these pivotal experiences.

From my perspective as an analyst, much like Bank of America CEO Brian Moynihan stated, the consumer isn’t inherently flawed, but if the Federal Reserve fails to act on interest rate reductions, we could face a substantial challenge. The central bank is also observing similar indicators within the system. Understanding that they cannot afford to undermine consumer trust, policymakers are proactively addressing potential issues before they escalate into major problems. Instead of waiting for something to malfunction, they’re trying to stay one step ahead.

Moving ahead, the transition is expected to trigger a sequence of reduced interest rates. This could provide a solid foundation for sustained economic expansion, boost consumer trust, and potentially spark a continuous upward trend in speculative assets such as Bitcoin and Ethereum.

Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.