Inflation Fatigue

Americans have been on a spending binge for the past few years, first on goods — everything from cars and bikes to electronics while they were living, studying, and working at home — then on services and experiences, they were unable to enjoy during pandemic lockdowns. This spending has propelled the US economy and helped it sidestep a recession over the past two years.  

Spending was initially supported by unprecedented federal income support, and further aided by a historically rapid rebound in the job market. In the face of Fed interest-rate hikes, the boom has lasted far longer than anticipated. However, a March 2024 study by the San Francisco Federal Reserve indicated that American households have now fully depleted their excess pandemic-era savings.[1]

As prices continue to rise, it raises the question, at what point will consumers just not be able to take it? For economists and investors, that is a complicated conversation about consumer resiliency and fatigue. Inflation wears people down, and it’s starting to show. 

There are signs that the US consumer is still spending, especially on experiences, but stubbornly high prices are squeezing consumers with lower incomes. A ‘K-shape’ is emerging, with higher-income consumers continuing to spend on experiences while lower-income consumers are being pinched by rising prices on basic goods and higher interest rates.  

A Morgan Stanley survey showed that 60% of US consumers are planning a summer vacation this year — and just about half of those traveling are expecting to spend more than they did last summer. Travel companies, including Priceline, have similarly indicated there are no signs consumers are taking shorter vacations or trading down in their hotel choices. At its Las Vegas resorts, Caesars said overall spending is still strong, and cruise lines are seeing record bookings even as prices have soared.[2]

When it comes to more discretionary items and everyday purchases, the picture looks quite different. Consumers are being more tight-fisted due to economic headwinds including elevated food costs, rising mortgage rates, and higher monthly PG&E bills for electricity and basic utilities. Even McDonald’s had to recently announce a renewed focus on greater affordability this year, with CEO Chris Kempczinski saying in their Q1 earnings call that lower-income customers were forgoing the golden arches to eat more cheaply at home.[3] Consumers have been delaying large home improvement purchases amid the economic uncertainty – impacting companies like Home Depot and Lowes. 

While overall spending remains strong, early cracks are emerging, suggesting that consumers are feeling the fatigue after four years of inflation pressures. Lower-income consumers are trading down to more value-conscious items and using ‘buy now, pay later’ services with increasing frequency. Only time will tell whether this is a blip in the larger trend of a strong American consumer, or if these are the early indications of a shift in consumer patterns.  

Many companies that raised prices during the recovery from the pandemic cited higher costs for the ingredients, materials, and labor needed to provide the goods and services that consumers were racing to buy. Those cost increases, exacerbated by supply chain issues in late 2021, helped push the annual inflation rate to a four-decade high of more than 9% by summer 2022. As of March 2024, inflation has fallen to 3.5%, meaning overall prices are still going up, albeit more slowly. 

General Mills recently cited “a continued challenging consumer landscape” as sales in its pet food businesses, including the Blue Buffalo brand, fell 4% on a yearly basis. The company admitted it had overestimated customers’ willingness to pay higher prices for dog treats, and doesn’t plan to implement additional price increases this year.  

Kraft Heinz, the maker of iconic mac-and-cheese and ketchup brands, reported a 7.1% decline in yearly sales, suggesting it was hitting the limit of how far it could hike prices before customers explored cheaper alternatives. The company raised prices by 2.5% across its product line over the course of 2023, after doing so by 14.2% the previous year. Kraft Heinz CFO Andre Maciel told analysts on their Q1 earnings call that the company expects to lift prices by only about 1% this year. 

Alternately, some companies that raised prices less aggressively over the past year were rewarded. After raising prices for its burgers by 7% in October 2022, Shake Shack increased them by only 1% in October 2023. The company reported that same-store sales jumped 2.8% over the course of the year, and traffic grew by 1.4%. Walmart similarly focused on lowering prices to cater to budget-conscious consumers, and early results have been positive.  

Businesses’ wholesale costs for many raw materials, contracts with suppliers, and other inputs are still elevated, with the closely watched Producer Price Index recently posting its biggest increase in five months. While it is unlikely consumers will see brands making deep price cuts anytime soon, many companies are now more inclined to “swallow some of the cost increases” they’re shouldering, rather than pass them on to consumers completely. 

If inflationary pressures are increasingly absorbed by companies, US households will experience some relief, and paychecks and savings can be stretched further. This is ostensibly a positive for the US consumer. The ripple effect, however, is that corporate earnings would decline if profit margins get squeezed, creating new headwinds for stock growth and retirement savings. It is a balancing act, and we expect that the Fed will rely on data to inform their next policy decisions, but it’s likely that they won’t be able to get the timing perfectly right on when to lower rates and the economic impact could be uneven. 

For long-term investors, this moment of transition in consumer spending doesn’t change the investment strategy. We will continue to stay invested while looking for opportunities to rebalance into stocks when prices dip or to lock in gains when prices rise. While there could be a bumpy transition period for the economy, our perspective is that the current pivot towards more value-conscious consumers and an ebbing of the post-pandemic ‘revenge spending’ is ultimately a healthy shift. 

Resources

[1] Pandemic Savings Are Gone: What’s Next for US Consumers? Federal Reserve Bank of San Francisco 

[2] Americans are shopping less but they’re still spending on flights, hotels and Disneyland CNN 

[3] McDonald’s Seeks to Make Menu More Affordable for Inflation-Weary Consumers WSJ