Key Takeaways:
Americans are spending more than ever — and getting less for it.
U.S. consumer spending rose at a 4.2% nominal annual rate in May, but with headline inflation accelerating to an estimated 4.2%, real purchasing power effectively flatlined, deepening the stagflation trap that has taken hold since the Iran conflict disrupted global energy markets in late February.
"Americans are upset about high prices and trying to stretch every dollar, but they aren't as gloomy as they were during the Great Recession, the COVID recession or just after 'Liberation Day' last year," said Heather Long, chief economist at Navy Federal Credit Union.
The Conference Board's consumer confidence index slipped to 93.1 in May from an upwardly revised 93.8 in April, while the University of Michigan's sentiment gauge collapsed to 44.8 from 56.6 over the same period. The S&P Global Manufacturing PMI input prices index surged to 80.0 — its highest since mid-2022 and a 22-point climb since February that mirrors the pace of the 2021-2022 inflation crisis. Average U.S. gasoline prices jumped to $4.96 per gallon from $2.98 in February, a 66% increase driven by shipping disruptions through the Strait of Hormuz.
The divergence between nominal and real spending is the core problem facing policymakers. Two-thirds of consumers reported cutting back on overall spending due to rising prices, according to a Conference Board supplementary survey, with most delaying purchases of discretionary items. Inflation has outpaced wage growth for the first time in three years, and real wages fell in April for the first time since 2023. The share of households viewing jobs as "plentiful" dropped to its lowest since February 2021, even as the unemployment rate held at 4.3%.
The Fed's policy trap tightens
The Federal Reserve now faces its most constrained policy choice since the 1970s. The benchmark overnight interest rate sits at 3.50%-3.75%, and financial markets expect no cuts into 2027 as inflation pressures broaden. The Dallas Federal Reserve estimates that core inflation would be at 2.3% — within striking distance of the Fed's 2% target — in the absence of Trump's tariff regime. A separate Fed paper estimates that a six-month closure of the Strait of Hormuz adds 0.79 percentage points to headline inflation, meaning the Iran conflict alone is responsible for roughly a fifth of the current price surge.
The last time the U.S. experienced a comparable combination of rising input costs and weakening consumer demand was in mid-2022, when the Manufacturing PMI input prices index last touched 80. At that time, the Fed was in the early stages of its most aggressive hiking cycle in four decades. Today, with rates already restrictive and fiscal stimulus absent, the central bank has far less room to maneuver.
Stagflation's grip on household budgets
The transmission from energy markets to household balance sheets has been direct and brutal. Gasoline prices have risen more than 50% since the war began, disproportionately hitting lower-income households earning $15,000 to $39,999 annually — the cohort that experienced the sharpest decline in confidence this month, according to the Conference Board. Credit card balances have reached record levels above $1.3 trillion, and delinquency rates continue to rise.
Consumers are adapting by shifting spending toward necessities and away from big-ticket items. Plans to buy a house declined as mortgage rates climbed, while plans to purchase automobiles and major appliances shifted to "no" from "yes" over the past month, the Conference Board said. Even vacation plans — which initially held up — are now being reconsidered, with consumers planning to increase spending on services shifting from "yes" and "maybe" to "no" responses.
The broader economy continues to grow — GDP expanded at a 2% annual rate in the first quarter — but that growth is increasingly concentrated in the AI investment boom, which has lifted stock values and supported spending by higher-income households. Excluding AI-related categories, business investment fell at a 3% annualized rate over the past four quarters, according to the Economist, after rising at a 5% average rate over the preceding decade.
For the Fed, the path forward offers no good options. Cutting rates would risk accelerating inflation further. Holding steady risks deepening the slowdown as consumers and businesses pull back. The next consumer price index release, due June 11, will provide the clearest signal yet of whether the May data marks a peak in inflation pressures or the beginning of a sustained reacceleration.
This article is for informational purposes only and does not constitute investment advice.
