Americans kept spending in May despite surging costs, with income growth absorbing the pressure but the resilience that supports economic growth is the same force keeping a Fed rate hike firmly on the table.
U.S. consumers are holding up remarkably well despite nearly $4 a gallon gas and an inflation that continues to deviate widely from the central bank goal. With core personal consumption expenditure inflation running at a 3.3% annual pace, well above the Fed’s 2% target, and the average 30-year mortgage rate still above 7%, there is no denying the fact that the household budgets are getting squeezed.
Spending Defies the Squeeze
That said, Thursday’s Bureau of Economic Analysis (BEA) data told a different story. Consumer spending climbed 0.7% month over month (MoM) in May, faster than April’s 0.4% rise and the 0.6% growth expected by economists.
What is enabling consumers to keep spending despite persistent inflationary pressures and growing economic uncertainty?
Income Growth Doing the Heavy Lifting
One reason could be the improvement in consumers’ wherewithal. Personal income continues to grow at a decent clip. In May, personal income kept pace with spending, rising 0.7%. Disposable income, which measures income after current taxes are deducted, was up 0.3%, providing households with additional capacity to sustain spending.
More fundamentally, consumers tend to spend when they feel secure in their employment prospects. While job growth has slowed from the post-pandemic boom, it has picked up pace in recent months despite all talks of technology-enabled productivity growth making jobs redundant. The jobless rate remains historically low and fairly stable.
Thriving US Labor Market
Source: Statista
Wage growth continues to outpace inflation in many sectors. As long as households believe their paychecks are secure, they are more likely to absorb higher prices rather than dramatically cut back on spending
Savings Rate Holds
Notably, the personal saving rate held steady at 3% in May. This suggests consumers are largely sustaining spending through ongoing income growth rather than meaningfully drawing down savings. That is a healthy dynamic for now, but it leaves less room for consumption to remain resilient if income growth slows or the labor market begins to soften.
Source: BEA via St. Louis Fed
The composition of spending is equally important. Much of the increase came from services, suggesting consumers continue to prioritize experiences, travel, healthcare, and other discretionary activities. Services spending tends to be less sensitive to
The resilience of consumers creates a paradox for policymakers. Strong spending signals that households remain financially healthy and that recession risks are limited. The final first-quarter GDP estimate released Thursday underscored the same theme. Consumer spending remains the backbone of the U.S. economy, helping keep overall interest rates than purchases of big-ticket goods, helping explain why overall consumption remains resilient even as borrowing costs stay elevated.
Fed's Uncomfortable Takeaway
Robust demand can make it harder for inflation to return to target, particularly in the services sector where labor costs play a dominant role. In other words, the very strength that is supporting economic growth may also be slowing the disinflation process.
For the Federal Reserve, the picture is uncomfortable. A consumer that keeps spending despite higher rates suggests demand is not cooling fast enough to return inflation to the 2% target on the Fed's preferred timeline. With nine of eighteen Federal Open Market Committee (FOMC) members already penciling in a rate hike by year-end, Thursday's spending data does little to shift that calculus. In fact, it may quietly reinforce it.