Charting the global economy: Consumer spending weakens in US

Consumer Spending Falters as Economic Uncertainty Grows

Amid growing concerns over inflation persistence, rising interest rates, and shifting labor dynamics, recent data indicates a softening in consumer spending in the United States—a trend that could ripple through the broader global economy. While the U.S. economy has shown resilience in the face of tighter monetary policy, cracks are beginning to appear in the one sector that has long served as its bedrock: consumer spending.

According to the latest data from the U.S. Department of Commerce, personal consumption expenditures (PCE) rose just 0.2% in May, a slowdown from April's 0.3% increase. When adjusted for inflation, real consumer spending was flat, reflecting growing caution among households.

Inflation Fatigue and Interest Rates Erode Purchasing Power

The Federal Reserve’s aggressive interest rate hiking cycle—aimed at cooling inflation—has made its mark. With the benchmark rate currently in the 5.25–5.50% range, borrowing costs for mortgages, credit cards, and auto loans remain elevated, squeezing household budgets.

“Consumers are feeling the pinch,” said Diane Swonk, Chief Economist at KPMG. “While job growth is still positive, wage gains are being offset by high prices, particularly in housing and services. We’re witnessing a behavioral shift in spending patterns, with more prioritization of essentials over discretionary purchases.”

The PCE price index, the Fed’s preferred gauge of inflation, rose 2.6% year-on-year in May—still above the central bank’s 2% target. Sticky inflation, particularly in service sectors like healthcare, insurance, and education, continues to limit real income growth.

Signs of Weakness Across Retail and Services

U.S. retail sales, a key barometer of consumer sentiment, surprised analysts by remaining virtually flat in May. Categories like furniture, electronics, and home improvement saw notable declines, while online retail and groceries posted modest gains.

Retailers are adjusting to these changing dynamics. Target Corp. recently downgraded its full-year sales forecast, citing "ongoing cautiousness in discretionary spending." Meanwhile, Walmart remains relatively resilient due to its broader mix of value-based essentials, indicating a bifurcation in consumer behavior.

In the services sector, spending on travel and hospitality has plateaued after a post-pandemic boom. According to the U.S. Travel Association, domestic travel spending is expected to slow to 2.5% in 2025, down from 6.8% in 2024.

Labor Market Still Strong, But Wage Growth Slows

Despite headwinds, the U.S. labor market remains tight, with the unemployment rate holding steady at 4.0%. However, wage growth appears to be moderating. Average hourly earnings rose 3.9% year-on-year in May, compared to 4.4% in the same period last year.

“We are past the peak of wage inflation,” noted Mark Zandi, Chief Economist at Moody’s Analytics. “That’s a double-edged sword. While it may ease pressure on the Fed to hike rates further, it also reduces the real income buffer households had against inflation.”

Moreover, labor participation remains below pre-pandemic levels, especially among prime working-age women and older adults, contributing to a structural tightness in some segments of the job market.

Global Implications: U.S. Consumption as a Key Driver

As the world’s largest consumer economy, the U.S. accounts for nearly a quarter of global GDP. A slowdown in American consumption could reverberate through supply chains and emerging markets heavily reliant on U.S. demand.

China’s export numbers, for example, showed a 9% decline in shipments to the U.S. in May, reflecting softening demand. Similarly, European luxury brands like LVMH and Kering have reported slower North American sales, offsetting strong performance in Asia.

“Any sustained dip in U.S. consumer spending would dampen global trade growth,” warned Catherine Mann, a member of the Bank of England’s Monetary Policy Committee. “It’s not just about retail sales—U.S. consumers influence global demand across commodities, technology, and financial services.”

Federal Reserve’s Tightrope Walk

The Federal Reserve faces a delicate balancing act. While progress on inflation is evident, policymakers remain cautious. The central bank held interest rates steady in June but signaled the possibility of one more hike if inflation fails to trend decisively downward.

Fed Chair Jerome Powell emphasized in a recent speech: “We are not declaring victory yet. The path to a soft landing remains open but narrow. Continued vigilance is necessary.”

Investors, meanwhile, are closely watching for signs of a pivot toward rate cuts. Fed fund futures now imply a 65% probability of a rate cut by December 2025, as markets begin to price in weakening economic data.

Investor Outlook: Defensive Plays and Cautious Optimism

With consumer-led growth moderating, analysts suggest that investors may benefit from shifting to defensive sectors like healthcare, utilities, and consumer staples. Dividend-yielding stocks and short-duration bonds are also gaining favor.

“We’re advising clients to stay selective,” said Lori Calvasina, Head of U.S. Equity Strategy at RBC Capital Markets. “The equity market has been buoyed by AI-driven tech stocks, but beneath the surface, economic fragility is increasing. We expect volatility in the back half of the year.”

Credit card delinquencies, a leading indicator of consumer strain, have also begun to rise, prompting concerns among financial institutions. However, strong corporate balance sheets and high savings buffers, particularly among upper-income households, could provide a cushion.

A Slowdown, Not a Collapse

While the data suggests a cooling in consumer spending, it is far from signaling a full-blown recession. The U.S. economy remains fundamentally sound, but the days of unchecked consumer exuberance appear to be waning. As the Federal Reserve stays the course on inflation, households and investors alike are preparing for a more cautious, value-oriented economic cycle.