Is the US consumer engine running out of steam?

The main factors underpinning the unusually strong performance of American consumers are losing momentum at the same time, indicating that the recent decline in household demand may not be one-off.

Real disposable income has increased only slightly over the past year. The savings rate is currently at a 16-month low, and most households have basically used up the extra cash they saved during the pandemic. As a result, many Americans are also increasingly dependent on credit cards and other sources of financing to support their expenses.

These factors help explain why actual spending, excluding the effects of inflation, fell in April, and consumer spending on cars, restaurants, and entertainment activities declined. As the job market is cooling down, companies like Best Buy have noticed shoppers turning to cheaper brands in recent months.

“Labor market momentum is slowing and will continue to limit income growth. As savings buffers decrease and debt burdens rise, more households are beginning to restrain spending,” EY chief economist Gregory Dacko said in a report on Friday. “Household spending momentum will gradually cool down in light of increased price sensitivity.”

US consumer spending, adjusted for inflation, fell unexpectedly in April. Furthermore, the US economy's growth rate in the first quarter was lower than the initial value, providing quite convincing evidence that the US economy is breaking away from the unexpectedly strong growth pace in 2023.

There have been debates in recent weeks about whether policy interest rates, which have been high for more than 20 years, have dampened the economy as expected by the Federal Reserve, but the latest data may give Fed officials some relief.

The main reason for the controversy is the strong performance of American consumers over the past few years. While this helped the US economy to repeatedly ignore expectations of a recession, it also puzzled Wall Street economists and Federal Reserve officials. Strong labor demand, savings during the pandemic, and drastic salary increases are the reasons behind it.

However, since inflation is still quite stubborn, forcing the Federal Reserve to keep interest rates high, the US economy has finally begun to slow down, and demand for employment has also declined from the peak of the epidemic, which means that employers' wage increases will not be that fast. According to the personal consumption expenditure report, wages increased by 0.2% in April, the smallest increase in five months.

Recent company earnings show that consumers are increasingly preferring to buy essential goods over large non-essential items.