Inflation Takes Its Toll On American Consumers

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Black Friday sales begin at the King of Prussia shopping mall in Pennsylvania
People carrying shopping bags walk inside the King of Prussia shopping mall, as shoppers show up early for the Black Friday sales, in King of Prussia, Pennsylvania, U.S. November 26, 2021.

Rising inflation took its toll on the American consumers in May, as evidenced by the University of Michigan May Consumer Sentiment index released Friday. It came in at 59.1, down from 65.2 in April, the lowest number in more than a decade thanks to a spike in the cost of living as measured by several indexes.

The first index is the Consumer Expectations inflation, published by the Federal Reserve Bank of New York early in the week. It came at an annual rate of 6.3% for April, easing slightly from 6.6% in March.

The second index is the Consumer Price Index (CPI), a measure of inflation at the retail level, published by the Bureau of Labor Statistics (BLS) on Wednesday. It rose at an annual rate of 8.3% in April, slightly below 8.5% in March. However, core inflation, which excludes the volatile food and energy component from calculations, rose 6.2%, meaning that inflation is now spreading beyond food and energy.

The third number is the Producer Price Index (PPI), a measure of inflation at the wholesale level, published by BLS on Thursday. It came at 11%, a sign that prices will remain elevated for several months as retailers pass the wholesale price hikes on to consumers.

Rising inflation diminishes the actual value of incomes, especially people's incomes at the low end of the income distribution. Thus, it depresses consumer sentiment, and eventually consumer spending.

"Consumers' assessment of their current financial situation relative to a year ago is at its lowest reading since 2013, with 36% of consumers attributing their negative assessment to inflation," reads the Michigan report. "Buying conditions for durables reached its lowest reading since the question began appearing on the monthly surveys in 1978, again primarily due to high prices. The median expected year-ahead inflation rate was 5.4%, little changed over the last three months, and up from 4.6% in May 2021."

Depressed consumer sentiment is a mixed blessing for the U.S. economy. On the one hand, it's a sign that the U.S. economy is slowing down, as consumer spending counts for close to two-thirds of the GDP, which dived in the first quarter of 2022 due to the strong dollar that depressed U.S. trade. Thus, a significant drop in consumer spending could push the U.S. economy into a recession by the end of the second quarter. That's when GDP drops for two consecutive quarters in a row.

On the other side, depressed consumer spending could help ease inflationary pressures, making it easier for the Federal Reserve to bring inflation under control without significant interest rate hikes.

This Friday, Wall Street seems to focus on the second rather than the first scenario, sending all major averages sharply higher in early morning trade. It remains to be seen whether the rally will hold on to the end of the trade session or doom to fade like many rallies lately.

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