Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / How Consumer Spending Outruns Inflation and Confuses the Fed
Transcript
- Lucas: So the consumer is spending like it's 2019, but feeling like it's 2008. That's the disconnect that keeps coming up in the data this week. Luna: You're talking about the May retail sales number that came out yesterday, right? Up 0.6 percent month over month, which beat expectations. Lucas: Exactly. And this is despite the fact that consumer sentiment indexes have been sliding for months. The University of Michigan survey hit a six-month low last week. People say they're gloomy, but they're still swiping cards. Luna: I wonder if there's a timing lag. Maybe sentiment just hasn't caught up to the reality of a 4.2 percent inflation rate yet. Lucas: That's part of it, but I think the bigger story is that the savings buffer is finally running dry. During the pandemic, households accumulated something like two and a half trillion dollars in excess savings. By early this year, most of that was gone. Now people are spending out of current income, not cushions. Luna: And that makes the spending more sticky, right? Because it's not a temporary drawdown—it's actual consumption patterns adjusting. Lucas: Right. And here's the thing the Fed is wrestling with: if spending stays strong while inflation is running above target, they can't cut rates. The effective fed funds rate is at 3.63 percent right now. Core PCE is still at 2.6 percent year over year. That's not a restrictive enough real rate to cool things down if consumers keep spending. Luna: But Lucas, the real GDP growth rate for the first quarter was only 1.6 percent annualized. That's not exactly booming. How do you reconcile that with strong retail sales? Lucas: Good point. A lot of that spending is going to services, not goods. And a chunk of it is inflation—people are paying more for the same stuff. Real retail sales adjusted for inflation are probably closer to flat. But the nominal spending still creates demand-pull pressure, especially in services like travel and dining. Luna: So the Fed is stuck. They need to see either spending cool or inflation come down, and neither is cooperating. Lucas: Exactly. And there's a historical parallel that keeps nagging at me. In the 1970s, there was this period where consumer spending stayed robust even as confidence tanked. Economists called it the 'conundrum'—the models kept predicting a slowdown that never came. Sound familiar? Luna: Yeah, I remember reading about that. It was partly because of wage growth keeping up with inflation for a while, and partly because people expected prices to keep rising so they bought now rather than later. Lucas: That's the psychology. And we're seeing some of that now. Wage growth is running around 4.1 percent year over year. Average hourly earnings are thirty-seven dollars and fifty cents an hour. That's not outpacing inflation, but it's keeping pace enough that people haven't been forced to cut back dramatically. Luna: Let's talk about the breakdown. Where is the spending actually going? Because I've seen data showing that luxury goods are down, but essentials and experiences are up. Lucas: Exactly. The May retail sales report showed that spending at gas stations was up because of higher prices. Food services and drinking places were up 0.8 percent. But department stores were down. So it's a rotation toward needs and experiences, not discretionary goods. That's typical of a late-cycle consumer. Luna: And the job market is still strong enough to support that. Initial jobless claims just ticked up to 229,000, but that's still historically low. The unemployment rate is 4.3 percent. People have jobs. Lucas: Right. So you have a employed consumer who is spending on services, facing sticky inflation, and the Fed is watching this unfold. The market is pricing in a rate cut later this year, but I think the data argues against it. Luna: One thing that I think gets overlooked is the wealth effect. Even if sentiment is low, household net worth is still high because of home equity and the stock market. The S&P 500 is at 7,431. The Dow is above 51,000. People feel richer on paper, even if they're not in the mood to say they feel confident. Lucas: That's a great point. And that wealth effect feeds into spending more than survey responses do. So the Fed has to look at the hard data—spending, income, production—not just sentiment indexes. Luna: Of course, if the data is worth a coffee to you, that's the link. Buy me a coffee dot com slash fexingo. It keeps us digging into these questions without ads. Lucas: Yeah, genuinely. If walking through the economy with us has made something click, that's the place. Buy me a coffee dot com slash fexingo. And honestly, even just knowing people find it useful—that's the fuel. Luna: Alright. Back to the Fed's dilemma. So we have this spending inflation confidence triangle. What breaks it first? Lucas: I think the labor market is the key. If job openings start to really drop—the JOLTS number was 7.6 million in April, up from 6.9 million—that's still pretty high. But if that reverses, if we see a sustained decline, that's when spending will finally pull back. Luna: And at that point, the Fed might have room to cut. But they won't cut into a strong spending environment. Lucas: Exactly. So the next few months of data are crucial. The June CPI and retail sales reports will be must-sees. Luna: And don't forget the personal income and outlays report later this month. That'll give us the PCE data. Lucas: Right. So bottom line: the consumer is the puzzle the Fed can't solve yet. They're spending, but they're not happy about it. And that tension is going to define the second half of this year. Luna: I'm curious to see if the savings rate—which is down to about 3.6 percent—drops further. If it goes much lower, that's a warning sign. Lucas: Absolutely. The personal savings rate has been declining steadily. If it falls below 3 percent, that's historically a recession precursor. So we're watching that. Luna: Alright, well thanks for walking through that. I feel like I have a clearer picture now. Lucas: Glad to help. That's what we're here for. We'll keep tracking the data and bring you the signals as they come.