Consumers Are Powering Through Higher Prices. That Complicates the Fed’s Fight.

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Prices are souring, interest rates are rising, and the federal stimulus that carried the economy through the past two years is now in the rearview mirror—all of which is bearing down on the American consumer at once.

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Consumers, however, aren’t letting any of it slow them down.

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Americans are on a spending spree, going shopping, planning vacations and dining out at restaurants in April even as gas prices spiked and inflation outpaced wage gains. Retail sales climbed 0.9% month over month, and March retail spending was revised significantly higher as well.

That’s a good sign for the current strength of the US economy, showing strong consumer demand amid significant headwinds. It’s a reflection of a healthy labor market—nearly 1 million more Americans are taking home paychecks now than were at the start of the year—and the roughly $2 trillion in excess savings that Americans piled up during the pandemic, which households are beginning to spend down.

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And it helps to dismiss any fears that a downturn is imminent. “You simply don’t have recessions with the consumer this healthy,” Ryan Detrick, chief market strategist for LPL Financial, wrote this morning after April’s retail sales data was released.

But unabating consumer demand can be a double-edged sword, in part because it reinforces the aggressive path that the Federal Reserve has signaled it plans to follow this year and suggests that continued monetary policy tightening will be needed. The data underscores that the US economy remains red-hot—and while that means recession looks less likely for now, it also could require the central bank to remain hawkish over the long term.

“Consumer resilience = Fed headache,” read the headline on a research note Tuesday from Diane Swonk, chief economist with Grant Thornton.

“The resilience of the US consumer is also an ability to sustain the inflation,” Swonk told Barron’s in a phone interview. “So the good news is the consumer is resilient. The bad news is it means the Fed has to be even more aggressive in its move to hike rates.”

“That resilience,” she added, “is exactly what the Fed is worried about.”

The challenge is that the more the Fed needs to tighten monetary policy—and the faster that it needs to raise interest rates—the more difficult it will be to achieve a so-called soft landing, or to successfully tamp down inflation without tipping the economy into a recession.

Fed Chairman Jerome Powell, who had long been bullish on the central bank’s chances of success, has more recently implicitly acknowledged that current economic conditions are making that more difficult—noting that bringing inflation back down from its current levels will inflict “some pain” on American families.

For that reason, while strong consumer demand is a good sign for now, it could portend a tougher road for the economy over the long term if it requires a more aggressive rate-hike path, with all the inherent risks that come with it.

For now, though, there are some early signals that economists say show consumers are starting to react to higher prices: Spending on areas that are seeing the fastest price gains—gasoline, for example—is falling once adjusted for inflation, the April data shows . And consumer sentiment has dropped to its lowest level in more than a decade.

But demand broadly remains strong on goods and is growing in the services sector, as more Americans feel comfortable returning to their prepandemic lifestyles and spending more time out at restaurants and bars even when they have to dip into their savings to do it.

And that persistent demand looks poised to keep the economy red-hot for the time being, despite surveys showing how Americans are more worried about inflation than anything else, As Gus Faucher, chief economist with PNC, put it: “Pay attention to what consumers are doing, not what they’re saying.”

Write to Megan Cassella at [email protected]


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