The buying behaviors of consumers are complex and historically tough to predict. In The General Theory, economist John Maynard Keynes offered a number of subjective motives, for example, that could impact individuals’ spending habits, including, “to satisfy pure miserliness.” Other than concrete factors such as a pay raise, spending and consumption could also be impacted by “shortsightedness” and “ostentation.”
All the variables that go into consumer behavior mean lots of uncertainty — for what is a large portion of the U.S. economy. (What will people spend their money on, how much, and when?)
That’s of particular interest this week because last Friday, a Bureau of Economic Analysis report showed consumer spending jumped 1.8% in the month of January while the core personal consumption expenditures (PCE) price index increased 0.6% (4.7% year-over-year) — a larger rise than in any of the last four months of 2022. That followed an earlier mid-February report showing the consumer price index fell only slightly in January, to 6.6% year over year.
If consumer buying proves resistant to nearly 5% core PCE inflation, the entire U.S. economy has a problem — to reduce inflation to the Federal Reserve’s 2% target, a higher terminal Fed funds rate may be required. That could hamstring the U.S. economy, putting a damper on the stock market and purchases of interest-rate sensitive goods such as homes and autos.
Since the next consumer spending release (“personal income and outlays”) isn’t until March 31, leading indicators like consumer sentiment become important to watch.
Expectations for where jobs, incomes, and business conditions are headed over the next six months all fell sharply in February. — Atman Ozyildirim, The Conference Board
On Tuesday, The Conference Board released its latest Consumer Confidence Index report. Consumer Confidence fell in February, to 102.9, down from January’s 106 (revised downward). The index fell lower than that just three times in 2022 and only twice in 2021 (in the first two months of the year). (See chart, How Do Consumers Feel?)
While a majority of the surveyed consumers felt jobs were still plentiful, “expectations for where jobs, incomes, and business conditions are headed over the next six months all fell sharply in February,” according to a statement by Ataman Ozyildirim, senior director, economics, at The Conference Board.
Consumers may be “showing early signs of pulling back spending in the face of high prices and rising interest rates,” said Ozyildirim. Fewer consumers, according to the Conference Board survey, plan to purchase autos or homes in the next six months, and “they also appear to be scaling back plans to purchase major appliances,” he said.
But a severe dip in that kind of spending has yet to materialize. According to BofA Global Research, with supply shocks fading, U.S. inflation is, for now, a demand problem, according to Aditya Bhave, U.S. economist at BofA Securities. “The strength in the January activity and inflation data suggests that the Fed might have to hike considerably further to find the point of pain for the consumer,” Bhave wrote in a February 27 note.
So what about January’s spending number? Some economists think the 8.7% cost-of-living-adjustment to Social Security benefits, an increase in the minimum wage in some states, and statistical variations caused the jump.
After all, consumers certainly expect inflation to remain high — February’s Conference Board measure of consumer inflation expectations for the next 12 months was 5.4%. And the University of Michigan’s measure of “expected price changes during the year” rose slightly to 4.1% in February. Both numbers are 1.5 to 2 percentage points from their peaks last spring but remain high relative to pre-pandemic readings.
For many U.S. workers, sustained inflation at those rates would mean a contraction in real income for 2023, making it hard for them to maintain their level of discretionary purchases.
And if the economy took a different path — a full-blown recession, for example — consumer spending would probably also fall as unemployment rose.
The Fed’s medicine for inflation — rising interest rates — also poses a problem for consumers. Consumer credit grew nearly 8% in 2022, keeping some spending elevated, but credit availability might be past its peak. The January Senior Loan Officer survey found that a significant number of U.S. banks tightened standards for consumer loans, including credit cards and auto loans, and demand for those loans weakened.
More borrowers are also falling behind on their payments, which in the case of some consumer debt increase as the benchmark rate does. The share of current U.S. consumer debt becoming delinquent rose in the fourth quarter, according to a Federal Reserve Bank of New York release on February 16.
“Although historically low unemployment has kept consumer’s financial footing generally strong, stubbornly high prices and climbing interest rates may be testing some borrowers’ ability to repay their debts,” said Wilbert van der Klaauw, a New York Fed economic research adviser.
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