|By increasing interest rates and, eventually, allowing assets to roll off its balance sheet, the Federal Reserve hopes that aggregate demand for goods and services will slow, easing the fierce competition for purchases that has driven the recent acceleration of inflation, without bringing the economy to a complete standstill or causing a severe recession.
However, the Fed’s suggested timetable for rate hikes is very gradual, and households are apparently in no hurry to slim down spending. Indeed, last week’s retail trade and food services report showed that sales grew by 0.9% in April and were 8.2% higher than a year ago.
While those figures alone are strong, they could have been even higher had it not been for the recent slide in gasoline prices, curbing sales at gas stations by 2.7%. Moreover, consumers have been transitioning their purchases away from goods and toward services, a segment that is largely missing from the report, as the only services spending it captures is at bars and restaurants. In other words, total consumption in April likely grew more than retail sales figures suggest.
By category, sales grew the most in the miscellaneous category, up by 4% over the month, which includes the likes of office supply stores, gift shops, pet stores and other specialty stores. This group of stores hardly represents more cost-conscience shoppers who are trimming their spending by choosing cheaper brands and merchandise, behavior that Walmart recently noted its customers engaging in.
The supply-constrained backlog of cars and trucks eased slightly as sales at dealerships grew by 2.2% in April. Meanwhile, sales at nonstore retailers, which include e-commerce stores such as Amazon, also grew by 2.2% in the month.
This is a far cry from showing that households are easing up their spending. Yet such retail therapy at inflated prices is losing its effectiveness, as consumer sentiment continues to fall, according to a survey by the University of Michigan. Its latest Survey of Consumers showed sentiment falling by 9.4% in May over the prior month, with consumers’ assessment of their current financial condition at its lowest since 2013 and expectations for the near future falling by 9.9%.
The Fed’s recent rate increases have so far done little to curb spending as households have been willing to borrow more to finance their purchases. The New York Federal Reserve Bank reported that household debt grew by 8% year over year in the first quarter of 2022, the steepest increase since the first quarter of 2008. Credit card debt, specifically, grew by 9.2% year over year, but mortgage debt rose by 10% over the year, more than any other category, unsurprising given the run-up in housing prices.
The median existing single-family home price is now 64% higher than it was in January 2018, according to the National Association of Realtors . The return on investment of a $40,000 down payment on a $240,000 home that month is today roughly 500% as the median price is now almost $400,000. The wealth effect of this increase in home equity allows households to boost spending, in many cases by refinancing at lower interest rates and taking out cash to make large purchases.
The Wealth Effect of Homeownership Likely To Ease
But signs are emerging that rampant home price appreciation is finally weighing on the housing market, which could reduce the impact of the wealth effect in the future. Existing home sales fell by 2.4% in April and were 5.9% lower than a year earlier, according to NAR, and new home sales tumbled by 16.6%, the steepest monthly decline since July 2013, according to the Census Bureau. Prospective buyers are increasingly being priced out of the market. With rising mortgage rates, NAR’s housing affordability index, which measures the ratio of the median family income to the income needed to qualify for the median-priced home, fell to its lowest level in April since November of 2007.
While consumers may not yet be responding to higher rates by trimming spending, businesses are starting to adapt to the new policy environment and adjust to higher costs of materials and labor. In the housing market, homebuilders are expressing a good degree of pessimism. The National Association of Home Builders reported a sharp decline in homebuilder sentiment in its recent survey. Its Housing Market Index fell from a value of 77 in April to 69 in May, its fifth consecutive month of declines and its lowest value since June 2020, as hopes for strong buyer traffic dimmed.
Producing Less of Everything Probably Won’t Help To Lower Inflation
Manufacturers have also started to scale back production. The Institute for Supply Management's Purchasing Managers Index for manufacturers fell to 55.4 in April from 57.1 in March, its lowest reading since July 2020. The index for non-manufacturing fell to 57.1 in April from 58.3 in March. Values over 50 indicate continued expansion, but it’s clear that April has seen a slowdown in response to rising rates and costs.
Consumers have so far been reluctant to cut spending at stores, but we will see a more comprehensive picture of household spending with Friday’s release of personal income and outlays for April, which will include the services side of the economy.
What We’re Watching …
If consumers start to pivot away from strong spending, recession fears will multiply. The release will also update the personal consumption expenditure price index, the Federal Reserve’s preferred measure of inflation. This indicator tracks slower than the consumer price index and is expected to show inflation at around 6% for the year in April.
CoStar Economy is produced weekly by Christine Cooper, managing director and chief U.S. economist, and Rafael De Anda, associate director of CoStar Market Analytics in Los Angeles.