June Economic Commentary: Retailers Implement Price Cuts to Address Changes in Consumer Spending Patterns
Economic data was generally more subdued during May, indicating a slow start to the beginning of the second quarter. The trend of disinflation is broadening out the longer that interest rates remain elevated. This, of course, is what the Federal Reserve is hoping for, but it will take several months of softer inflation data to convince the Federal Open Market Committee (FOMC) that pricing pressures are on a sustainable path to their target of 2.0% inflation.
Inflation Trends
After the strong monthly readings in the first three months of the year caused progress on reducing inflation to be called into question, there was slightly better news on the headline and core readings of the April Consumer Price Index (CPI), both of which came in at 0.3%. This enabled the headline year-over-year measure to ease to 3.4% from 3.5%, while the core eased to 3.6% from 3.8%. The Fed’s preferred measure of inflation, the core Personal Consumption Expenditure index (PCE), rose by 0.2% in April bringing its year-over-year reading to 2.8%, which was unchanged from March.
Year-over-year inflation readings remain above the Fed’s target of 2.0%. Because monthly inflation readings were soft during much of the second half of 2023, it will be difficult to see much progress on the yearly inflation numbers until late 2024, unless this summer’s monthly numbers come in consistently below 0.2%.
Consumer Spending & Lending
Consumer spending, which accounts for 69% of GDP, recorded a weaker than expected gain in April of 0.2%, down from the strong showing of 0.7% in March. On an inflation adjusted basis, spending was down 0.1% in April. Real disposable personal income was also down 0.1% in April and is only growing 1.0% year-over-year. With savings having been drawn down to 3.6% and credit card balances approaching their limits, consumer spending is expected to continue to be less robust than seen in 2023 and thus a drag on GDP.
Banks continue to cite a less favorable or more uncertain outlook and greater risk aversion as reason for tightening credit standards on commercial and industrial (C&I) loans. At the same time, banks, on balance, are reporting weaker demand for C&I loans, consumer loans, and commercial real estate loans. Delinquency rates on credit cards have begun to rise sharply among highly indebted borrowers and those with low credit scores. Consumer credit growth in April increased by a modest amount that brought the year-over-year growth rate down to 1.9%, the slowest growth in three years. High interest rates and tighter lending standards are slowing the growth of revolving credit.
Most signs of stress are being seen in low-income households, but changes in spending patterns are happening across all income categories. Retailers see the reluctance of consumers to pay high prices, and some are starting to cut prices. Target has lowered prices on 5,000 food products and household items, and Walgreens announced price cuts on over 1,000 items. These are just two of many examples of retailers responding to consumers’ aversion to high prices.
Key Indices & GDP
The Leading Economic Indicators (LEI) index has declined in 25 out of the last 26 months and continues to point to a fragile outlook for the U.S. economy. The weakness in the April LEI was broad-based with new orders, consumer expectations, interest rates and building permits the main drivers of the month’s decline.
The May ISM Manufacturing Index posted another reading below 50 at 48.7, indicating moderate contraction that was mainly driven by new orders falling to a 12-month low. The ISM Services Index, on the other hand, recovered from its weak April reading, and rose to 53.8, suggesting that the April slowdown in services was only temporary.
The second reading of first quarter 2024 GDP was revised down to 1.3% from 1.6% (annualized), driven by a downward revision to growth in real consumer spending. Spending on goods showed weakness while spending on services held up better.
Employment & The Labor Market
In the labor market, various reports are providing mixed signals. The Establishment report on employment in May showed a surprisingly strong increase of 272,000 in non-farm payrolls, but the unemployment rate increased to 4.0% – the highest level since January 2022. Calculation of the unemployment rate comes from a different survey, the Household Survey, which showed a large 408,000 decline in employment along with a 250,000 drop in the labor force. There was a 0.4% increase in average hourly earnings which moved the year-over-year growth rate up to 4.1% from 3.9%. In yet another report, the Job Openings and Labor Turnover Survey (JOLTS), demand for labor continued to ease with job openings falling to their lowest levels since February 2021. The ratio of job openings to unemployed is back to its pre-pandemic rate. At the same time, JOLTS indicated that layoffs remain low, and the quits rate is at a three-year low.
Employment reports are notorious for being revised, so it’s premature to draw any strong conclusions from this recent data. The response rate for the Establishment report has declined from 60% pre-pandemic to only 43.5%, helping to illustrate why revisions are prevalent. The best that can be said is that supply and demand in the labor market are continuing to move into balance. This is important to monitor as any deterioration in the labor market will exacerbate the trend of weaker consumer spending.
The Fed’s next meeting is June 11-12, and the Fed is expected to keep interest rates unchanged. Regarding employment, the FOMC tends to focus on the Establishment employment report, and with its ongoing strength, the Fed can continue to patiently wait for better inflation numbers before making the initial interest rate cut. Of particular interest this meeting will be the updated Summary of Economic projections for the remainder of the year and through 2026. Projections for GDP, core inflation, and the number of interest rate cuts in 2024 will be closely watched, as markets are currently pricing in just one interest rate cut to occur in December.
