Consumers keep spending as Fed hikes bite

Despite the University of Michigan’s Index of Consumer Sentiment hitting record lows—lower than during the 1970s inflation, the Great Recession, and the Covid pandemic—actual consumer spending has remained surprisingly resilient. Adjustments for polling methodology and partisan bias suggest that sentiment levels may not be as dire as raw data indicate, aligning more closely with other measures like the Conference Board’s, which show confidence down from 2019 but relatively stable. This divergence highlights a complex consumer psyche where reported pessimism does not fully translate into spending behavior.

Retailers like Lovisa report strong demand for clothing and accessories even amid a 15% decline in consumer sentiment across major markets, underscoring persistent consumer spending despite financial strains. However, this spending resilience masks underlying credit stress, with credit card balances soaring to $1.25 trillion and rising delinquencies in auto loans, which are being stretched to record terms amid weak auto sales. Meanwhile, housing market stagnation due to homeowners holding low mortgage rates dampens spending on related goods, revealing pockets of financial constraint beneath the surface of steady retail sales.

Consumers are increasingly trading down purchases—even among higher-income households—reflecting cautious financial management amid credit strains and inflation pressures. Tax refunds have temporarily buoyed spending, offsetting rising gas prices, but concerns remain that sustained fuel cost increases could erode lower-income households’ spending capacity. This nuanced behavior is evident in retail trends showing growth in discretionary categories like sporting goods and nonstore sales, fueled in part by lower gas prices freeing up income for non-essential items, illustrating a complex interplay between constrained budgets and selective spending.

Underlying this divergence is a drawdown in savings, with the personal savings rate falling to around 2.7%, indicating that consumer spending resilience is not driven by strong income growth but rather by households dipping into savings. While short-term volatility is expected as temporary tailwinds like the World Cup and tax refunds fade, a solid labor market supports a broadly positive spending outlook. Yet, as Ahmed Riesgo from Insigneo notes, the consumer is doing 'okay'—not spectacularly strong but managing to sustain spending amid economic headwinds and persistent low confidence.

Renewed geopolitical tensions involving Iran, particularly near the strategic Strait of Hormuz, have triggered significant oil price shocks that are throttling global markets and exacerbating inflationary pressures. This volatile backdrop, compounded by the Federal Reserve's persistent hawkish stance, is forcing U.S. retailers to adopt cautious inventory management strategies amid a fragmented economic recovery. Bank CEOs have voiced concerns that these Iran-driven disruptions, coupled with inflation jitters and AI-induced market volatility, threaten to squeeze U.S. consumers and rattle financial markets, underscoring a complex economic environment that advisors must monitor closely.

The Federal Reserve's hawkish stance, underscored by anticipated rate hikes totaling 75 basis points this year, reflects a determined effort to rein in persistent inflation overshoot—a challenge Fed officials like Robert Kaplan acknowledge has lingered for five years. This tightening bias is reinforced by a growing consensus within the FOMC that financial conditions remain too easy, prompting expectations of a flatter yield curve and elevated front-end rates. These policy moves occur amid a backdrop of Iran-driven inflation pressures and geopolitical tensions near the Strait of Hormuz, which together with AI-fueled market volatility, are rattling markets and contributing to a K-shaped U.S. recovery that sharply divides consumer experiences.

Despite rising inflation expectations—evidenced by the median one-year-ahead forecast climbing to 3.7%, the highest since September 2023—consumer behavior reveals a paradoxical resilience. Shoppers are hedging bets through cautious tactics like hoarding and deal-hunting amid shaky confidence, yet overall spending remains robust across income cohorts. This complex interplay between hawkish Fed policies, persistent wage pressures indicated by declining unemployment claims, and cautious but sustained consumer spending underscores a nuanced consumer psychology that simultaneously fuels economic growth and market complexity.