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Over the past couple of years, there has been a somewhat confounding phenomenon going on with American consumers. They say the economy is terrible and are up in arms about inflation, but despite all that, many of them are spending their way through it. American shoppers will not be stopped — or, at least, they haven’t been stopped yet.
Consumers have largely been hanging in there, economically. Stimulus checks and savings built up during the pandemic have left them with extra cash they’ve been eager to spend. Retail sales seemed to slow at the end of 2022, but in January 2023, they rebounded once again. Despite the fact that many companies have increased prices in order to offset their own rising costs, they’ve also taken advantage of the inflationary moment to raise prices and increase their profit margins to their highest level in decades — if everybody knows everything’s getting more expensive, it’s easier to get them to go along with rising costs. Plenty of executives were quite open about what was going on.
But now, it appears the tide may be turning on how far consumers can be pushed. That extra money people were able to save during the pandemic is dwindling. Household debt is up. Delinquency rates on credit cards and auto loans are still below where they were before the pandemic, but they’re starting to creep back up, and it appears younger borrowers, in particular, are struggling. The amount of disposable income people will need to pay their debts is “likely to surpass and remain much higher than pre-pandemic levels — representing a real financial strain on households and consumer spending capacity,” wrote Greg Daco, chief economist at EY-Parthenon, in market commentary on February 22.
“What we’re seeing in terms of the health of consumers’ balance sheets is that they are rapidly deteriorating. We’re seeing not just an increase in the transitions into delinquency but also an increase in the debt servicing costs because of higher interest rates and because the levels of leverage are rising. And then we’re also seeing banks and financial institutions being more cautious with credit,” Daco said in an interview with Vox. “So the combination of all of those elements is a risky one when it comes to the prospects for consumer spending.”
It’s an issue corporate America can’t ignore. Profit margins, while still high, are starting to come down. Some companies, such as Kraft, are slowing price increases after driving them up last year. In certain corners, there seems to be a recognition that companies might not be able to squeeze consumers as much as they could, say, a year ago. Shoppers won’t and can’t always be along for the ride. They may start making trade-offs or scale back spending.
“We are seeing some manufacturers continuing to test the resilience of the consumer, and it will depend on individual manufacturers and brands how that goes for them, but there is some inherent risk there because they have some optionality,” said Katie Thomas, who leads the Kearney Consumer Institute. She explains that consumers “are increasingly savvy at figuring out what the best bang for their buck is. They do online research, they price-compare.”
The consumer is the backbone of the American economy. That backbone is starting to bend.
That pandemic cash that helped people weather inflation is running out
When inflation started to take off in the US in 2021 and 2022, many consumers were generally decently positioned to handle the situation. Government measures such as stimulus checks, the expanded child tax credit, and boosted unemployment insurance left people with more cash than they might have had otherwise. Beyond that, shutdowns generally meant people were spending less money overall on going to restaurants, on vacation, etc.
“They were less interested in trying to shop around, find a deal, push back,” said Mark Zandi, chief economist at Moody’s Analytics. “They had the cash, and they were willing to spend it to buy whatever it is they wanted.”
Excess savings peaked above $2 trillion in 2021 and has started to dwindle as government stimulus has run out and the economy has gotten back to normal. Personal savings rates have declined as well. In the fourth quarter of 2022, household debt hit a record $16.9 trillion, and, as mentioned, delinquencies — meaning falling behind on payments on debts — also rose. Consumers aren’t in a disastrous situation, but they’re not as well positioned as they were. They also face an economy where inflation, while cooling, is still an issue and interest rates on their debts are rising.
“Particularly lower-income households, they’re out of cash,” Zandi said. “They’re turning to debt to try to supplement their income, and they’re having trouble paying down that debt.”
That shift in household finances means companies can no longer assume that consumers will have the ability or the will to accept higher prices, Daco said. “You have to be cognizant of that, and you have to understand that if you’re playing in a market where prices are extremely important … then you may not necessarily have that much pricing power, so you may have to consider your discounting strategy and consider how consumers may trade down in the current environment.”
Companies could have to cool it a little on prices
At some point, there will be a line people won’t cross, price-wise. They’ll start to change up what they’re buying, maybe buying generic items instead of name brands, or just buying fewer or different things altogether. Apples get too expensive, consumers start buying oranges.
Throughout much of last year, companies were quite open that the line consumers wouldn’t cross was pretty far and, in some cases, farther than they anticipated. Procter & Gamble, for example, noted that it found people were more accepting of its price increases than expected. Kellogg has said consumers are handling the higher prices, too.
Now that may start to shift in some cases. Kraft Heinz has said it won’t hike prices anymore in 2023 after increasing them by 15.2 percent overall in 2022. Inflation was 6.5 percent for the year ending in December, less than half that.
Arun Sundaram, vice president of equity research at CFRA Research, who covers companies throughout the supply chain, said there’s generally a lag between when a company’s costs go up and when they pass them on to consumers. Inflation started to creep up in 2020 and 2021, and it wasn’t until 2022 that more companies increasingly started to pass that creep through. And because of the inflationary environment, they were able to. “In normal times, pre-Covid, for example, it was a lot harder to pass higher costs to the retailer and then to the consumer because there would be a lot of negotiation, tension between the retailer and the packaged food companies,” he said. “But over the past two years, it was just well understood that everyone’s costs were going up at an exponential rate.”
In 2023, things have changed. “It’s well understood that cost pressures are easing. It’s not like costs are going down, but they’re not going up at the same rate, so because of that, we’re starting to see a little more pushback from retailers,” Sundaram said. “It won’t be as easy to raise prices going forward.”
Thomas, from the Kearney Consumer Institute, said she’s started to hear rumblings from some retailers pushing back on price increases from manufacturers because they get blamed by the consumer. People don’t get mad at Procter & Gamble because the price of their Pantene shampoo went up; they get mad at Walmart. “While consumers will complain, they probably won’t necessarily move away from the retailer completely, but that doesn’t mean that they want to be the ones taking the brunt of consumer frustration,” she said, noting that consumers often believe retailers have much higher profit margins than they actually do. “People don’t in general understand that really these are the manufacturers pushing through these price increases.”
Wherever the blame is cast, some companies may still want to test consumers with prices — General Mills, for example, just lifted its business forecast based on price hikes and strong demand. It now becomes a dance of how far consumers are willing to go and, in turn, how far retailers and manufacturers will take them.
Sundaram said that consumers are being more thoughtful about purchases now than over the past couple of years. They’re more responsive to promotions and discounts, which are also appearing more because supply chain problems have begun to be worked out. He said sales volumes may be down, but they’re not down nearly as much as many companies feared. “Most manufacturers think that their sales volumes are going to decline more this year,” he said. “The big question is how much steeper will the volume decline be in 2023, because they weren’t nearly as bad as most people expected in 2022.”
Beyond consumers feeling the pinch in their wallets, they are also paying closer attention to prices now — and they might be a little more dubious of companies’ claims that prices have to go up because everything’s so much more expensive across the economy. Companies should be in a position to raise prices more slowly because their costs are now rising more slowly.
“Inflation is getting better, supply chains are getting better, but price increases seem to be more testing consumers and if they’ll take it than real cost issues,” Thomas said. “Now it does seem to be a little bit more of a profit and margin play than a necessity.”
Companies that continue to increase prices run the risk of losing consumers, and when that happens, it can be hard to get them back. If they trade for a generic brand, they might find they like it just fine and stick with it.
“A lot of companies raised prices last year or so and they feel like they can’t keep doing that; the continued escalation in prices is going to reduce their profits, not increase them,” said Michael Strain, director of economic policy studies at the American Enterprise Institute, a center-right think tank. There are concerns about headwinds ahead. “If you’re a company and you think there’s a recession coming, that probably has an impact on your pricing strategy that will be different than if you’re a company that thinks that demand for your products is going to continue to be strong,” Strain said. Of course, a potential recession is on consumers’ minds, too.
Consumers at the bottom of the income spectrum will be hit the hardest
The economy is generally in pretty decent shape right now, even if it doesn’t feel that way. The job market is strong, GDP has been growing, and consumers have kept up spending. But if and when consumers do push back and scale back, it’s probably not going to be coming from everyone equally.
In his recent market commentary, Daco suggested the US is likely to see a K-shaped consumer spending pattern in 2023 where low- and median-income families will have to be more careful about spending and people at the higher end of the spectrum will be able to keep going (though, perhaps, with more discretion). “For lower-income families, their excess savings have vanished, and they are now dipping into their regular savings and using credit to offset the burden of inflation,” he wrote.
“People, I think, are thinking a lot more about the cost of things that they’re purchasing,” Zandi said. “They’re becoming much more choosy in what they’re buying because they have to, particularly lower-income households.”
Again, all is not doom and gloom. Many workers, especially those at the bottom of the income spectrum, have seen their wages go up significantly over the past couple of years, though it hasn’t necessarily been enough to keep up with inflation. Generally, people have reason to feel good about the job market overall.
Still, there’s been this sneaking feeling that the other shoe is about to drop on the economy for months. Whether or not the US economy enters recession, it does show signs of slowing down. That’s, theoretically, the goal if we want to get inflation under control. But it doesn’t mean it’s not going to be a bumpy ride or that it’s not going to be painful for some people.
We live in a consumerist society, and for the past couple of years, as frustrating as inflation has been, it’s been nice for many people to be able to participate and to have the money to spend if they wanted to, especially people who aren’t used to having that luxury. It could soon be the case that consumers who have had to pinch pennies forever have to start doing so again.
It’s probably also worth noting that, amid all this, a lot of companies are still going to come out on top. “The bottom line is that big corporations are still doing very, very well thanks to price hikes and inflation, whether those price hikes were implemented now or at the beginning of last year,” said Rakeen Mabud, chief economist and managing director of policy and research at Groundwork Collaborative, a progressive think tank. “Because of decades of rampant consolidation across industries in our economy, it’s very hard for consumers to push back against these price hikes.”
Consumers might soon get some more leverage to be able to push back, if only because they’ll have no other choice.
