Consumer Sentiment Remains Near All-Time Lows
Many households continue to deal with inflation by drawing from their savings and borrowing from credit cards, home equity lines of credit and other sorts of loans. While pent-up demand has driven increased spending on travel and food services for some households, many others are shifting a larger proportion of their spending to necessary items, such as food and beverages.
The 1% increase in June’s retail sales over the month derived almost entirely from rising prices. Nowhere was this more evident than at gasoline stations, where sales grew by 3.6% over the month. While gasoline sales usually account for about 9% of retail sales, they accounted for more than a third (36.5%) of that 1% gain in sales. Moreover, sales at gas stations have grown by 49% over the past 12 months.
The shift toward online retail was evident once again in this month’s report. Sales from nonstore retailers, which include Amazon and other pure e-commerce retailers, grew by 2.2% in June and 9.6% over the past 12 months. Many cost-conscious shoppers frustrated by rising inflation are opting for the lower prices that are often offered by nonstore retailers, as these sellers generally have lower real estate and labor costs.
Uncertainty in the economy is leading many households to scale back on big-ticket items that are often available at home improvement, general merchandise and electronics stores. Rising mortgage rates have also reduced home sales and caused mortgage payments on newly purchased homes to rise, another reason why these stores are seeing fewer shoppers. In contrast, however, higher rates on auto loans have had a smaller impact on sales at motor vehicle and parts dealers, where sales grew by 0.8% in June. Here, however, many new car buyers have been waiting months to purchase vehicles that have been backordered due to the global chip shortage, so sales gains have been largely restricted by supply woes.
While consumers are just starting to adapt to price changes over the past two years, inflation is back on the rise and could remain elevated for a longer period than many economists had forecast. In June, the consumer price index grew by 1.3% and 9.1% over the past 12 months, the fastest annual pace since November 1981. The core CPI, which excludes the more volatile food and energy items, accelerated for the fourth consecutive month, with a monthly gain of 0.7% growth in June.
Worse news is that inflation is reaching a broader set of categories. No longer is it just physical goods that have been affected by supply chain disruptions that have seen prices surge. Rather, prices for services continue to accelerate, growing by 6.2% compared to a year ago. And while price growth of goods has been higher, rising prices of services tend to signal prolonged growth in inflation because goods can be overproduced and then see prices collapse as inventories are overbuilt, while services are usually made to order. For example, changes in fashion trends, seasonal recreational items and perishable foods cause retailers to regularly slash prices of items that are no longer in demand. If consumers pull back on spending, these discounts could yield prices that are set below production costs to salvage some of the loss. In most services, however, firms can immediately reduce output when customers are not willing to pay prices that are at or above production costs. Trimming labor costs by laying off or furloughing workers generally does not leave service providers with overstocked shelves, as it may do for factory owners.
The danger is that inflation will become entrenched, with both consumers and businesses expecting higher prices to continue for longer. Inflation expectations rose once again last month, according to the Federal Reserve Bank of New York. The median inflation expectation for one year ahead reached 6.8% in June — a series high from the survey that dates back to June 2013. But expectations for inflation three years from today fell from 3.9% in May to 3.6% in June and have been trending lower since late last year, a promising sign that runaway inflation can be avoided.
Ultimately, though, households are feeling torn from having to pay more for just as many goods and services. The Michigan Consumer Sentiment index remained near all-time lows in July, albeit slightly higher than the previous month. Consumers’ view of current economic conditions, in particular, has fallen dramatically, from nearly 115 in February 2020 before the pandemic struck to 57.1 this July. Apart from June and July, the last time the sentiment index of current economic conditions was below 60 was during the great financial crisis in the fourth quarter of 2008.
What We’re Watching …
So far, the consumer has been resilient in the face of rising inflation despite souring sentiment. Wage incomes have garnered some gains in the tight labor market, which might buoy consumers’ overall sense of financial well-being. The reality is that real wages have suffered a setback when adjusted for inflation. Even as spending patterns change to more economical or off-brand selections, households may still be feeling flush enough with padded savings accounts and solid credit lines to keep their wallets open. Once they decide it’s time to pull back, however, recession odds will really heat up.