Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Wage Growth Hasnt Boosted Consumer Spending as Expected
Transcript
- Lucas: So here's the puzzle we're staring at today. Average hourly earnings hit $37.60 in June, up about 2.4 percent year-over-year. That's real income growth above inflation for the first time in years. But consumer spending data? Flat to slightly negative in real terms. Luna: Right — the headline payrolls number was strong too, 158.984 million, up another 57,000. So more people working, earning more, yet they're not spending. What gives? Lucas: The Fed published a new working paper last week that tries to answer that exact question. Their argument is that higher wages are being eaten by debt service. We know credit card balances have been climbing — $1.15 trillion as of Q1 2026, up 8.4 percent year-over-year. Luna: So every dollar more in earnings is going straight to paying off debt, not to buying more stuff. That would explain the flat spending. Lucas: Exactly. The paper estimates that for households in the bottom 60 percent by income, the share of disposable income going to debt service is now above pre-pandemic levels. And those are the households that typically drive marginal spending. Luna: Which is interesting because the World Cup gave bars and restaurants a temporary boost — the Fed's Beige Book flagged that. But the paper suggests that was just a blip. Lucas: Right. The Beige Book said the World Cup bump faded quickly after the group stages. And now we're seeing import prices from China hit their highest since 2008. So retailers are facing higher input costs at the same time consumers are pulling back. Luna: That's a margin squeeze. Retailers can't pass through costs if consumers are already tapped out. Lucas: Precisely. And this is where the Fed's rate path gets tricky. The effective Fed funds rate is at 3.63 percent, and the market is pricing in two more cuts by year-end. But if wage growth stays positive and import prices keep rising, the Fed might worry that cutting too fast could reignite inflation. Luna: At the same time, if they hold too high, debt service burdens get worse and consumer spending could tip negative. It's a delicate moment. Lucas: The paper's authors point to one specific metric: the ratio of debt payments to disposable income. That ratio is now at 9.8 percent, up from 9.2 percent a year ago. That's not crisis territory, but it's the highest since 2019. Luna: And the real wage growth we mentioned — 2.4 percent — that's barely enough to offset the 0.6 percentage point increase in the debt service ratio. So net discretionary income is actually flat or down. Lucas: Right. And if walking through the economy with us has made something click, it's worth knowing that listener support is what keeps this show ad-free. People who find value here sometimes chip in at buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small way to keep the podcast independent and focused on the data. No pressure, just if it's useful. Lucas: So back to that Fed paper — they also break down the data by income quintile. The top 20 percent have actually increased their spending, but that's offset by the bottom 80 percent pulling back. Luna: Which makes the aggregate data look resilient even when broad-based health is deteriorating. Lucas: Exactly. And it explains why the Fed is reluctant to cut aggressively. They look at the headline numbers — 4.2 percent unemployment, 7.594 million job openings — and see a tight labor market. But beneath that, there's fragility. Luna: So what does the paper recommend? Just hold rates steady and hope wage growth outpaces debt accumulation? Lucas: Not exactly. They argue for a gradual easing that acknowledges the debt service drag. Their model suggests that if the Fed cuts by 25 basis points per meeting starting in September, it would stabilize the debt service ratio by mid-2027 without reigniting inflation. Luna: That's pretty dovish for a Fed paper. Usually these are more conservative. Lucas: It is. But the authors note that import prices from China are a wild card. If those continue rising, it could feed into core goods inflation even as domestic demand softens. Luna: Stagflation-lite scenario? Lucas: Maybe not full stagflation, but a period of sub-2 percent growth with sticky core inflation. The 10-year breakeven is at 2.24 percent, so the market is pricing in inflation expectations that are slightly above the Fed's target. Luna: And the 10-year Treasury yield is at 4.54 percent, which is still restrictive for housing and auto loans. Lucas: Right. The yield curve is no longer inverted — the 2-year is at 3.71, the 10-year at 4.54 — which historically signals a recession may be coming. But this time, the curve un-inverted because the Fed cut short rates, not because long-term rates fell. Luna: So it's a different kind of signal. More about policy easing than market panic. Lucas: Exactly. And that's why the Fed is watching consumer spending so closely. If the wage-debt dynamic we discussed today continues, they'll have to cut more aggressively to prevent a downturn. Luna: But if import prices keep rising, they can't cut too much. It's a tightrope. Lucas: It really is. And we'll be watching the July PCE report next week for the next clue.