Prior to the coronavirus pandemic’s arrival in America more than two years ago, the American consumer was like a diner at an all-you-can-eat buffet.
The choices were endless and prices were reasonable, store shelves were stocked with goods from around the globe and credit was plentiful at rock-bottom rates. But then the dishes started disappearing from the table and the diners were left with few choices and a tab that was growing by the day. You could eat whatever you wanted as long as it was meat and potatoes.
Today, some semblance of normalcy has returned. Supply chains are healing and people are able to go out to eat and entertain themselves. But prices have risen sharply and consumers no longer want those Pelotons, outdoor firepits and golf carts.
A massive shift in consumption patterns away from long-lived goods to services is underway and with it, some moderation in inflation is occurring. But whether it will be enough and happen in an orderly fashion, or lead the economy into a recession (which some believe is already here) is the looming question for the rest of the year.
Political Cartoons on the Economy
The data clearly shows the shift that is taking place. Last week’s consumer spending data showed that Americans are shifting their purchases away from goods to services. Spending on air travel increased 3.4%, adjusted for inflation, in May from April.
While the increase is not unexpected given the overall pickup in travel and leisure activity, “This further drives home the point that consumers are willing to spend on something they feel is worthwhile,” says Mike Graziano, consumer products senior analyst at RSM US LLP.
Likewise, data from audience data firm GWI shows that while 59% of consumers report being concerned about the cost of food, which along with energy is one of the two main drivers of current inflation, they are not spending less on groceries. Rather, they are buying more store brand items or purchasing larger-sized items to save money.
Bill Adams, chief economist at Comerica Bank, says that while spending remains relatively strong among higher-income consumers, those who can afford to splurge “are spending those dollars to dine out, go on vacation and take in other experiential services, not buy more goods.”
It’s a shift that should help drive inflation lower over time, as services prices tend to be less sticky than those for goods, especially high-ticket items like automobiles.
“This is how monetary policy works,” says Stephen Miran, a former Treasury official who now is co-founder and lead portfolio manager for Amberwave Partners. “Rising interest rates cause moderation in demand, which ultimately kills inflation.”
It may already be working. A report from supply managers in the manufacturing industry released last week found that an index measuring prices paid in May dropped to 78.5 from 82.2, a level equal to where it was in 2018 when consumer prices were running at an annual rate of 3%.
“CPI inflation was at a 40-year high in May, at 8.6% in year-over-year terms, but the ISM survey – along with drops in commodity futures prices for energy, foodstuffs and metals – suggest that inflation peaked in May,” Adams says.
“The period 2020-to-2021 was often called a K-shaped recovery, as the goods side of the economy boomed while the services side languished,” Adams adds. “That’s reversing now. The parts of the economy that went on a bender last year, supported by a flood of stimulus cash and distortions in consumer preferences, are suffering through a K-shaped hangover now as those temporary drivers of demand dissipate.”
That may explain why consumers are finding themselves in such a grumpy mood. The latest Forbes Advisor-Ipsos consumer confidence survey released last week found that overall confidence fell to 46.9 out of 100, driven largely by respondents who identified as Democrats or aged 18 to 34. Also, a drop was reported among those earning less than $50,000 annually.
The survey may have been affected by the Supreme Court’s ruling overturning the landmark 1973 ruling in Roe v. Wade, which legalized abortion, as a separate Ipsos poll found that half of Democrats polled described themselves as “extremely angry” at the decision.