Checking in on the US consumer

Inflation has stayed higher for longer than anyone expected. Meanwhile, interest rates have risen at an unprecedented pace and financial conditions have tightened considerably. Is the US consumer about to crack under the pressure?

Retail earnings reveal a mixed picture

Retail earnings last week revealed a mixed picture on the consumer. Walmart said some consumers faced with higher food and fuel prices were cutting back on some of the higher end clothing and general merchandise, in some cases trading down to the store brand or smaller items. Target noted that consumers were merely spending their dollars differently coming out of the pandemic, preferring to spend on gifts, entertainment and luggage rather than TVs and furniture. Home Depot meanwhile raised its full year guidance with demand for home improvement remaining strong.

Retail sales, however, do not tell the whole story about the US consumer. For one, it mostly captures spending on goods, not services. As the pandemic fades, consumer spending has been shifting away from buying TVs and refrigerators and towards leisure and entertainment activities such as dining and travel. Per capita guest spending at Disney’s domestic parks for instance increased by 20% over the prior year and was 40% higher than 2019 levels, as guests opened their wallets to cover higher prices on admissions, hotel stays, food, and merchandise.

Second, it is clear that inflation has a varying impact on different kinds of consumers. For lower income households, higher rent, food, and energy prices mean having to cut back on discretionary purchases. But homeowners sitting on a ton of equity may be less sensitive to rising prices of home improvement tools.

We are also in this peculiar environment where some typical effects of inflation aren’t being seen. For example, usually higher energy costs lead to people cutting back on things like leisure travel. But after years of lockdowns, people have already saved a lot and have pent-up demand. They are taking that family vacation, no matter what. So demand for air travel is soaring, testing airlines’ ability to fly enough planes.

A look at the broader economic data still points to underlying strength, although there are some points of concern.

Real income is falling...

Real consumer spending, or spending adjusted for inflation, posted a solid 2.7% annualized growth rate in the first quarter. But persistent inflation is eating into consumer spending power. Although job growth and wage growth are much stronger than usual, so is the pace of inflation. Without help from stimulus checks and enhanced unemployment benefits, income just isn’t rising fast enough to offset inflation. In March, real disposable income—the amount households have available to spend after taxes, adjusted for inflation—fell to its lowest level since March 2020.

..and so is the savings rate

With real income falling, the only way for households to spend more is for them to save less. In March, the personal savings rate was only 6.2%, the lowest in nearly a decade.

Consumer credit increased by a record high USD 52.4 bn in March, a likely sign that some people are relying on loans to sustain spending and meet their bills.

During the pandemic, households built up around USD 2.5 tn in “excess” savings as government checks rolled in and people were mostly stuck at home. So even though the savings rate is already lower than normal, we believe that there is room for it to fall further, especially considering the strength of the labor market.

However, there is also little doubt that many people are being squeezed by rising prices, especially lower-income households renting in tight housing markets. The official inflation data shows rents up by around 5% year-over-year, but the reality is that many households have seen much bigger increases than that.

Higher income households may feel less wealthy

Under these circumstances, we expect higher-income households to drive a lot of the consumption growth in the months ahead. These households were more likely to have kept their jobs when the pandemic hit, allowing them to build up their savings. Further, with national home prices up by around 20% over the past year, even for households that aren’t sitting on a lot of cash, home equity loans could be used to finance discretionary spending.

One possible negative factor is the sharp downturn in financial markets so far this year. Stocks have been flirting with bear market territory, with the S&P 500 closing just shy of it on Friday. Some investors may feel compelled to spend less in order to make up for the drop in the value of their portfolios.

But as long as the labor market stays healthy and consumers are optimistic about their job prospects, we expect consumer spending to remain robust.

Co-authored with Brian Rose, Senior US Economist

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