Robust Consumer Spending Could Be Bad News for Inflation

American consumers are proving to be more resilient than many market experts had expected in the tough economic climate, and this strength in spending is fueling the reacceleration in inflation. This might not, however, be good news for consumers or the Federal Reserve. The Fed’s preferred inflation gauge—the Personal Consumption Expenditures (PCE) price index—unexpectedly rose in April, climbing to 4.4 percent, according to the Bureau of Economic Analysis (BEA). The core PCE, which excludes the volatile energy and food components, also edged up to 4.7 percent. The PCE report revealed consumers are surviving amid an environment of high prices, rising borrowing costs, and a slowing economy. While real household income (inflation-adjusted) was flat, consumer spending advanced at a significant 0.8 percent in April, fueling the jump in prices. PCE figures were supported by the 0.4 percent rebound in retail sales in April, according to the Census Bureau (CB). Although they came in below economists’ expectations of 0.8 percent, retail sales were up from negative 0.7 percent in March. BEA and CB statistics highlight that spending has been broad-based, with shoppers allocating their consumption behaviors to both goods (durable and non-durable) and services, increasing by 0.8 percent and 0.5 percent, respectively. CB data confirm that the retail trade witnessed gains in sales at motor vehicle and part dealers, building material and garden suppliers centers, food services and drinking locations, health and personal care stores, and merchandise and non-store retailers. In addition, BEA staff found higher spending rates on motor vehicles, pharmaceutical products, professional and financial services, recreation, and health care. The State of the Consumer Despite real wage growth (inflation-adjusted) being stuck in negative territory, consumers have utilized two tools to fund their spending and cover higher prices: debt and pandemic-era savings. Recent Fed data revealed that consumer credit climbed 6.6 percent in March, up from the 3.7 percent increase in the previous month. This was driven by the more than 17 percent surge in revolving credit, such as credit cards. In the first quarter, credit card debt totaled $999 billion, the Federal Reserve Bank of New York reported in its quarterly Household Debt and Credit Report. A photograph of American Express credit cards, on March 17, 2016. (Kai Pfaffenbach/Reuters) The San Francisco Fed Bank published a report that found consumers still possess approximately $500 billion in excess savings. This cash was accumulated during the coronavirus pandemic when the economy was shut down, and the U.S. government flooded the economy with liquidity. Regional central bank economists anticipate this trend to persist. “We expect the aggregate stock of excess savings will continue to support consumer spending at least into the fourth quarter of 2023,” the report said. “However, uncertainty also surrounds this outlook, including the possibilities that households may now have a higher appetite for savings, significantly shift their spending habits, or receive other sources of income that offset the expired pandemic-era cash inflows.” So, are these consumer spending levels sustainable? Not quite, says Scott Anderson, the chief economist at Bank of the West Economics, who wrote in a note that “gray clouds are forming on the consumer spending front.” “The household income outlook, the high-octane fuel for overall consumer spending growth, is visibly bifurcating across income brackets,” he stated, citing the New York Fed Bank’s Survey of Consumer Expectations (SCE) figures that show households earning $100,000 or less anticipating “a sharper deterioration in expected future income gains.” Moreover, government social benefits started tumbling to kick off the second quarter, while low-income households report that their pandemic-era savings have been depleted. The overall personal savings rate clocked in at 4.1 percent in April. Credit growth has been solid, but various Fed reports confirm that the banking turmoil has resulted in tighter lending conditions. Further, more households believe access to credit will be harder a year from now. In addition, a Bankrate survey found that more than half (52 percent) of U.S. adults say money is hurting their mental health, up from 42 percent a year ago. The primary reason? Inflation. All this could start to weigh on consumers and their wallets. The Conference Board’s Consumer Confidence Index slipped in May to 102.3, down from 103.7 in April. Likewise, the Expectations Index— consumers’ short-term outlook for the economy, like income and the labor market—dipped to 71.5, down from 71.7. “Consumer confidence declined in May as consumers’ view of current conditions became somewhat less upbeat while their expectations remained gloomy,” said Ataman Ozyildirim, the senior director of economics at The Conference Board, in the report. At the same

Robust Consumer Spending Could Be Bad News for Inflation

American consumers are proving to be more resilient than many market experts had expected in the tough economic climate, and this strength in spending is fueling the reacceleration in inflation.

This might not, however, be good news for consumers or the Federal Reserve.

The Fed’s preferred inflation gauge—the Personal Consumption Expenditures (PCE) price index—unexpectedly rose in April, climbing to 4.4 percent, according to the Bureau of Economic Analysis (BEA). The core PCE, which excludes the volatile energy and food components, also edged up to 4.7 percent.

The PCE report revealed consumers are surviving amid an environment of high prices, rising borrowing costs, and a slowing economy. While real household income (inflation-adjusted) was flat, consumer spending advanced at a significant 0.8 percent in April, fueling the jump in prices.

PCE figures were supported by the 0.4 percent rebound in retail sales in April, according to the Census Bureau (CB). Although they came in below economists’ expectations of 0.8 percent, retail sales were up from negative 0.7 percent in March.

BEA and CB statistics highlight that spending has been broad-based, with shoppers allocating their consumption behaviors to both goods (durable and non-durable) and services, increasing by 0.8 percent and 0.5 percent, respectively.

CB data confirm that the retail trade witnessed gains in sales at motor vehicle and part dealers, building material and garden suppliers centers, food services and drinking locations, health and personal care stores, and merchandise and non-store retailers. In addition, BEA staff found higher spending rates on motor vehicles, pharmaceutical products, professional and financial services, recreation, and health care.

The State of the Consumer

Despite real wage growth (inflation-adjusted) being stuck in negative territory, consumers have utilized two tools to fund their spending and cover higher prices: debt and pandemic-era savings.

Recent Fed data revealed that consumer credit climbed 6.6 percent in March, up from the 3.7 percent increase in the previous month. This was driven by the more than 17 percent surge in revolving credit, such as credit cards. In the first quarter, credit card debt totaled $999 billion, the Federal Reserve Bank of New York reported in its quarterly Household Debt and Credit Report.

Epoch Times Photo
A photograph of American Express credit cards, on March 17, 2016. (Kai Pfaffenbach/Reuters)

The San Francisco Fed Bank published a report that found consumers still possess approximately $500 billion in excess savings. This cash was accumulated during the coronavirus pandemic when the economy was shut down, and the U.S. government flooded the economy with liquidity. Regional central bank economists anticipate this trend to persist.

“We expect the aggregate stock of excess savings will continue to support consumer spending at least into the fourth quarter of 2023,” the report said. “However, uncertainty also surrounds this outlook, including the possibilities that households may now have a higher appetite for savings, significantly shift their spending habits, or receive other sources of income that offset the expired pandemic-era cash inflows.”

So, are these consumer spending levels sustainable?

Not quite, says Scott Anderson, the chief economist at Bank of the West Economics, who wrote in a note that “gray clouds are forming on the consumer spending front.”

“The household income outlook, the high-octane fuel for overall consumer spending growth, is visibly bifurcating across income brackets,” he stated, citing the New York Fed Bank’s Survey of Consumer Expectations (SCE) figures that show households earning $100,000 or less anticipating “a sharper deterioration in expected future income gains.”

Moreover, government social benefits started tumbling to kick off the second quarter, while low-income households report that their pandemic-era savings have been depleted. The overall personal savings rate clocked in at 4.1 percent in April. Credit growth has been solid, but various Fed reports confirm that the banking turmoil has resulted in tighter lending conditions. Further, more households believe access to credit will be harder a year from now.

In addition, a Bankrate survey found that more than half (52 percent) of U.S. adults say money is hurting their mental health, up from 42 percent a year ago. The primary reason? Inflation.

All this could start to weigh on consumers and their wallets.

The Conference Board’s Consumer Confidence Index slipped in May to 102.3, down from 103.7 in April. Likewise, the Expectations Index— consumers’ short-term outlook for the economy, like income and the labor market—dipped to 71.5, down from 71.7.

“Consumer confidence declined in May as consumers’ view of current conditions became somewhat less upbeat while their expectations remained gloomy,” said Ataman Ozyildirim, the senior director of economics at The Conference Board, in the report.

At the same time, Americans have revised their inflation projections lower. Year-ahead consumer inflation expectations slid to 6.1 percent, down from 6.2 percent.

This is in addition to the  SCE easing to 4.4 percent in April, down from 4.7 percent. The University of Michigan survey also reported a drop in year-ahead inflation expectations, receding to 4.2 percent in May, down from 4.6 percent.

But consumers should not expect inflation to be vanquished from the economy, warns Ted Rossman, a senior industry analyst at Bankrate.

“A key point that I think a lot of people understate is the fact that the Federal Reserve’s efforts to lower inflation won’t bring prices back to 2019 levels—at least on a broad scale—certain categories might decline for various reasons, such as egg prices, which have started to come down after an avian flu outbreak caused prices to spike tremendously,” said Rossman in a statement. “Lower inflation means that prices will still generally be rising, just at a slower pace.”

According to the Cleveland Fed Bank’s Inflation Nowcasting model, the PCE is projected to ease to 3.9 percent, and the core PCE is predicted to be flat at 4.7 percent.

In the end, the full force of the Fed’s tightening has yet to be felt.

“The tightest point of Fed policy is probably going to be four to six months after the last hike, which is in conjunction with our overall recession calls,” wrote Wells Fargo economists Tim Quinlan and Shannon Seery in a research note.

Shopping at the Mall Impacts Fed Policy

Experts say that strong consumption levels could be a headache for the U.S. central bank as it decides to hit the pause button on tightening or continue raising rates.

After the key inflation gauge came in hotter than expected, policymakers could be forced to raise interest rates at the policy meeting of the Federal Open Market Committee (FOMC) in June. As a result, the futures market shifted its expectations and started pricing in a quarter-point rate hike, CME FedWatch Tool data confirm.

Fed Chair Powell
Federal Reserve chair Jerome Powell testifies in Washington, on June 23, 2022. (Win McNamee/Getty Images)

Since March 2022, Federal Reserve chair Jerome Powell and his colleagues have attempted to curb inflationary pressures by killing demand to slow the economy. However, a solid labor market has supported consumer spending, representing two-thirds of the national economy.

Fed officials argue that because the economy is performing better than the institution initially projected when it started tightening, policymakers have enough room to keep pulling the trigger on rate hikes to cool prices.

“I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” St. Louis Fed Bank president James Bullard told an American Gas Association financial forum on May 22. “As long as the labor market is so good, it’s a great time to fight inflation, get it back to target. Get this problem behind us and not replay the 1970s.”

The U.S. economy added a higher-than-expected 253,000 new jobs in April. The unemployment rate slipped to 3.4 percent. Annualized average hourly earnings edged up to 4.4 percent, while average hourly earnings surged 0.5 percent month over month.

The upcoming challenge for consumers, especially those with debt, will be their monthly interest payments. WalletHub reported that the Fed’s 500-basis-point boost to the benchmark federal funds rate would cost indebted credit card holders at least $33.4 billion over the next 12 months.

With a potential recession entrenched in economic forecasts, could a downturn be the deciding factor to force consumers to stop spending?