Consumers Confound Economists

When the government released its most recent update on US economic growth (GDP ), it was a classic “upside surprise”. The economy expanded by an annualized pace of 2.8 percent in the second quarter, far ahead of expectations of 2 percent, and a big jump from the first quarter result of 1.4 percent. The result was a joint effort: Businesses restocked inventories and bought equipment, the government stepped up its spending, and most importantly, consumers, who account for almost 70 percent of the economy, opened their wallets for health care, housing, cars and auto parts, and furnishings.

Before we get too excited about the positive report, it is possible that the rate will be trimmed when the second and third versions of Q2 GDP are released in the coming months. Additionally, some portion of the upside surprise has to do with?transportation?companies’ ramping up their spending in June, in order to make up for equipment?production probelms earlier in the year.

Meanwhile, consumer spending has confounded economists. Wealthier Americans have seen their home values and investments increase dramatically over the past five years. This group also has benefited from the rise in interest rates, as they locked in low, fixed rate mortgages and then enjoyed higher rates of interest on their safe money.

Still, there are not enough rich Americans to account for the totals, which means that everyone else is also spending more than expected. Low to middle Americans, many of whom have spent down their pandemic savings amid higher prices, are keeping the spigots open for two reasons: because their wages are now outpacing the inflation rate and also because they are increasingly turning to credit cards.

As long as the labor market remains firm, those in debt should be able to keep up. Overall, job growth has been better than expected this year. The economy produced an average of 222,000 per month in the first half of the year, but there is an expectation of a slowdown to start the second half: the consensus estimate for jobs for the July report is 175,000 with the unemployment remaining at 4.1 percent. Economists are also watching wage growth , which has been slowing recently, as well as credit card and auto delinquencies, which have been rising, as early signs that consumers may retrench later this year.

When will the Federal Reserve start providing relief to American borrowers? Probably not at the July policy meeting, which kicks off on July 30th and concludes on July 31st. Central bank officials have told us as much. In his recent testimony before Congress, Fed Chair Powell said that the Fed needs “More good data” before cutting rates and San Francisco President Mary Daly said that despite an improvement in inflation readings, “we're not there yet.”

There has been progress in getting there: the most recent release of the Fed’s preferred gauge of inflation (Core PCE Index ) showed that the 12-month annual core inflation rate remained unchanged at 2.6 percent, but the three-month annualized rate dropped to 2.3 percent, from 2.9 percent. (As a reminder: the inflation rate refers to the rate of change in prices, not a fall in prices. These numbers indicate that price increases are slowing down, which is called “disinflation”.) If the inflation rate continues to trend lower this summer, as most economists believe, and the job market remains resilient enough to keep consumers afloat, Federal Reserve officials could target their September meeting for the first rate cut of the cycle.