An economist has offered an explanation for the paradox emerging in recent data showing spending remains high even as consumers report pessimism.
Joan Xu, director of consumer sentiment research at the University of Michigan, said: CNBC on Friday that she believes Americans have abandoned plans to save money because they see their financial goals seem less achievable and are spending money instead.
“This positive spending is not a reflection of some inner secret feeling of confidence that consumers have,” he explained. “And instead, I think consumers are seeing many of the aspirational goals that we talk about as part of the American dream—home ownership, paying for college, paying for college for their kids, retiring comfortably—with high prices and high interest rates. now, these ambitious goals seem increasingly unattainable.”
And as a result, consumers have “gone away” from saving for these purposes, Xu added, noting that a still strong labor market allows them to spend money now.
The latest University of Michigan survey data showed sentiment fell to a six-month low of 67.4 in May from a final reading of 77.2 in April, as Americans cited persistently high inflation and interest rates and fears that unemployment could rise.
While that report was followed a few days later by the April Consumer Price Index, which showed a decline in inflation, it followed three straight months of unexpectedly high prices. Consumer companies have sounded the alarm about the impact of inflation and high rates, especially on low-income shoppers.
Of course, inflation has fallen sharply from a four-decade high of 9% in mid-2022 to 3.4% last month. But this means prices are not rising as quickly, rather than returning to pre-pandemic levels, and the build-up of shock over the past few years is still weighing on sentiment.
Meanwhile, consumer demand indicators remained at the same level. It continued to drive GDP growth in the first quarter. And despite the weak retail sales report, analysts noted an overall trend of continued spending.
For now, consumers expect the strong labor market to continue, giving them enough confidence to spend, but the latest data shows some softening, Xu warned.
“This may be an early sign of impending consumer weakness. But for now, high incomes are supporting consumer spending,” she added.
But the labor market also hinted at some cooling after record growth earlier this year. The Labor Department’s April employment report came in well below expectations, and the unemployment rate rose to 3.9% from 3.8% in March.
Further cooling in the labor market could also push the Federal Reserve to cut interest rates, giving consumers a reason to be a little less draconian.