News in Charts: US economic sentiment drops sharply

Fathom’s US Economic Sentiment Indicator fell sharply in March, dropping from 5.2% to 1.2%. This monthly indicator is designed to measure underlying economic activity. It uses a technique known as principal component analysis to distil the information from numerous consumer and business surveys into a single composite indicator. The ESI has been trained on quarterly GDP growth, and by construction has the same mean and variance as that series. It provides a monthly updated estimate of quarterly growth in underlying activity and displays less short-term volatility than quarterly GDP growth. Given the unprecedented shock that the US economy faces from COVID-19, and uncertain business and household reactions following a large stimulus, the ESI is unlikely to provide as accurate a reading of GDP in the near term than has historically been the case.

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Across the 23 business and household surveys that we use, all were down on the month. However, the fall was not always extreme. Within that group, almost half of the surveys, including the University of Michigan survey of consumers that measures current conditions, remained above their average since 1997. There remains some uncertainty as to what is driving this. With the US relatively late to announce lockdowns in many states, it could be that the surveys were carried out before the scale of the economic shock to come had become apparent. If that is the case, and with the Center for Disease Control having extended its social distancing guidelines until April, then we can expect a further steep drop in next month’s update.

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There is also the possibility that firms and households are behaving in a more rational forward-thinking way. The US government has already passed an ambitious fiscal package to support workers and businesses in the short term. It is likely that they will announce further measures in due course. Increased borrowing is being accommodated by the Federal Reserve, which has expanded its balance sheet dramatically, helping to keep Treasury yields low. Economic agents may be pricing in a temporary shock that unwinds in the summer and does not leave them materially worse off in the long term. Evidence from equity markets suggests investors do not think that is impossible. The S&P 500 has rallied from its lows, and is down 19% from its previous peak, after troughing down by 34%. This more benign interpretation seems unlikely. Even if people were really expecting a recovery, and pricing that in, the high degree of uncertainty about such an outcome, as well as the material health crisis would probably be sufficient to lead to further declines in optimism.

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