Consumer sentiment rebounds as oil falls 38% from war highs

American consumers are feeling better about the economy as falling gasoline prices and cooling inflation reverse a sentiment slump triggered by the Iran conflict earlier this year.

US consumer sentiment rose in June after plunging to a multi-year low during the first quarter, as the retreat in crude oil prices from war-era highs eased pressure on household budgets and restored purchasing power.

"The recovery in sentiment reflects the sharp drop in gasoline prices over the past two months, which has provided meaningful relief for lower-income households," said James Knightley, chief international economist at ING.

The Conference Board's consumer confidence index and the University of Michigan's sentiment survey both registered gains in June, according to data released Friday, recovering ground lost during the first quarter when energy costs surged following the outbreak of hostilities in the Middle East. The surveys showed broad-based improvement across income brackets, with consumers expressing more optimism about both current conditions and their expectations for the next six months.

The decline in gasoline prices has been the primary catalyst. The national average for regular unleaded has fallen more than 80 cents from its April peak, according to AAA data, as WTI crude retreated from levels above $110 a barrel reached after the Iran conflict began. West Texas Intermediate crude traded near $71 a barrel Friday, down 3.75% on the day and 38% below its 52-week high of $117.90. US crude oil inventories dropped 6.1 million barrels last week to 412.1 million barrels, the Energy Information Administration reported Wednesday, though the drawdown was not enough to halt the broader price decline driven by progress in US-Iran negotiations.

Inflation Data Complicates the Fed's Calculus

The improvement in consumer sentiment coincides with a mixed inflation picture that may complicate the Federal Reserve's policy path. May PCE inflation topped 4% year-over-year, up from 3.8% in April, while core PCE — which excludes food and energy — held at 3.3%, data showed this week. The reading leaves a Fed rate hike on the table, economists said, even as other parts of the economy show signs of cooling.

First-quarter GDP was revised to 1.6%, down from 2% in the prior quarter, and durable goods orders for May are expected to decline 5% when data is released Thursday. The combination of sticky inflation and slowing growth presents a challenge for Fed policymakers, who next meet in July. Markets currently price a 62% probability that the central bank holds rates at the current 5.25% to 5.5% range, according to CME FedWatch data.

What the Sentiment Recovery Means for Markets

The rebound in consumer confidence supports the case for a soft landing, where the economy avoids recession despite elevated interest rates. It is bullish for consumer discretionary stocks and retail, as it suggests households may be more willing to spend on non-essential items in the second half of the year.

The S&P 500 traded near 7,371 on Friday, up 0.08% on the session, while the 10-year Treasury yield fell 8 basis points to 4.40% as investors weighed the mixed signals. The last time consumer sentiment recovered this sharply after an energy-driven shock was in the second half of 2022, when gasoline prices fell from record highs above $5 a gallon. In the six months following that recovery, the S&P 500 gained 12% as recession fears receded.

For now, the path forward depends on whether oil prices continue to fall. Progress in US-Iran negotiations has been a key factor in the crude selloff, with both sides reporting constructive talks. If a deal materializes, Iranian barrels could return to global markets, pushing oil prices lower and providing further relief to consumers. If talks stall, the risk of renewed energy price spikes could reverse the sentiment gains.

This article is for informational purposes only and does not constitute investment advice.