Consumer confidence plummeted unexpectedly in March

Consumer confidence plummeted unexpectedly in March. However, thanks to the “wealth effect” created by rising home and stock prices, this dip doesn’t mean the economic recovery has faltered.

According to the Conference Board, consumer confidence fell to 59.7, down from 68 in February, and well below the 67.5 print anticipated by economists surveyed by Bloomberg. The Conference Board said the budget sequester has dimmed consumers’ expectations and made them less confident about the economy.

While this plunge is a surprise, it’s important to put the past several months into perspective. Indeed, the broader US economy has returned to a moderate growth rate over the past two months following a pause late last year, according to a Federal Reserve report issued March 20th. Labor markets have improved slightly since January, and household spending and business fixed investment (e.g. machinery, vehicles, and technology) have advanced.

More importantly, the rising stock market and rebound in house prices ought to help offset the negative effects of the sequester and drive momentum in the second half of the year, in our view. Consumers have shown a propensity to spend more when they see the value of their investment portfolios or home prices rise. This is referred to as the “wealth effect.” The exact impact on the economy is anyone’s guess, but according to several studies cited in a paper released by the Kansas City Fed in 2011, a $1 increase in housing wealth leads to an increase in consumption of 6 to 10 cents, versus an average increase of about 2 cents per $1 of additional stock market wealth. Using these estimates and the Federal Reserve’s Flow of Funds report, we believe nearly $40 billion of “wealth effect” consumption may have occurred in the first quarter of 2013. That alone should help offset the impact of about half the $85 billion in sequester-related cuts anticipated in 2013, in our view. Moreover, the stock market’s positive performance through March should provide an additional cushion in the second quarter.

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