The U.S. Consumer Is Still Spending — And That Complicates the Inflation Story

MWM Global Investment Research | Economic & Market Commentary

The August retail-sales report delivered one of the more important signals about the current state of the U.S. economy: the American consumer remains resilient.

Retail sales increased 1.2% month over month in August, rebounding from a revised decline in July. Total sales were approximately 6.0% higher than a year earlier.

But the headline number is not the most important part of the report.

The retail-sales control group increased 1.4% month over month, substantially stronger than the roughly 0.4% increase economists had expected.

For MWM, that 1.4% figure deserves particular attention because the control group more closely tracks the goods component used in calculating personal consumption expenditures and, ultimately, GDP. The implication is straightforward: Underlying consumer demand remains stronger than many expected. That is supportive of economic growth. But in the current inflation environment, it also creates a more complicated problem.

A Consumer That Has Not Yet Broken

For much of the current monetary-policy cycle, one of the central questions has been how long households could withstand elevated borrowing costs, higher prices and tighter financial conditions.

August suggests the answer remains: longer than expected. The strength was relatively broad. Online retailers experienced particularly strong sales growth. Spending also increased across restaurants and bars, electronics and appliances, sporting goods, furniture, clothing and motor vehicles.

Gasoline-station receipts increased as well, reflecting the impact of higher energy prices. That last point matters because retail sales are reported in nominal dollars rather than inflation-adjusted terms. Higher prices can therefore mechanically increase reported sales. But the breadth of August's increase—and particularly the strength of the control group—suggests that the report cannot simply be explained by higher gasoline prices. Consumers are still spending. And that has important implications for economic growth, inflation and monetary policy.

Why Strong Consumer Spending Can Become an Inflation Problem

Ordinarily, strong consumer spending is viewed positively. Consumption represents the largest component of the U.S. economy. When households spend, businesses generate revenue, inventories move, employees remain working and economic activity expands.

But economic data must always be interpreted within the prevailing economic regime. Today, the United States is simultaneously dealing with renewed pressure from energy prices, imported inflation, supply constraints and elevated financing costs.

That changes the interpretation of strong consumption.

The economic transmission mechanism MWM is monitoring looks like this:

Energy and supply shock

↓

Higher transportation, import and input costs

↓

Higher corporate operating expenses

↓

Businesses attempt to raise prices

↓

Consumers continue spending

↓

Corporate pricing power remains intact

↓

Inflation becomes more persistent

↓

Monetary policy remains restrictive

↓

The cost of capital remains elevated

This is where consumer resilience becomes a double-edged sword. Strong demand supports economic growth today. But strong demand can also make it easier for businesses to pass higher costs through to customers.

The Importance of Pricing Power

Consider what happens when a business experiences a substantial increase in transportation, energy, inventory or imported-input costs.

Management generally has several choices.

The company can absorb the higher costs and accept lower margins.

It can reduce expenses elsewhere.

It can attempt to increase productivity.

Or it can raise prices.

Whether the fourth option works depends largely on pricing power. When demand is weak, businesses have limited ability to raise prices without losing customers.

When demand remains resilient, that constraint becomes less severe. This is why the August retail-sales report matters beyond consumer stocks. It tells us something about the environment in which corporate pricing decisions are being made.

If consumers remain willing and able to spend despite higher prices, businesses with strong competitive positions may continue passing higher costs through the economy. That can extend the inflation transmission mechanism.

The Federal Reserve's Dilemma

This creates a difficult situation for monetary policy.

The Federal Reserve cannot manufacture additional oil.

It cannot increase refinery capacity.

It cannot eliminate geopolitical risk.

It cannot instantly repair disrupted supply chains.

And it cannot directly lower the price businesses pay for imported commodities.

What monetary policy can influence is aggregate demand.

Higher interest rates increase borrowing costs.

Higher Treasury yields affect mortgages, corporate financing and asset valuations.

Tighter credit conditions make capital more expensive.

Eventually, those forces can reduce household and business spending.

That is one of the primary channels through which restrictive monetary policy reduces inflation. But August retail sales suggest that transmission has not yet produced broad demand destruction.

The consumer remains active.

That raises an important question:

If higher prices do not slow demand sufficiently, will monetary policy eventually have to?

That is one of the most important questions facing markets.

Strong Growth Can Produce Higher Rates

This is why investors should be careful about treating stronger economic data as automatically bullish for financial assets. Strong consumer spending can support corporate earnings. But stronger demand can simultaneously reduce the probability of easier monetary policy. That creates competing forces.

Stronger consumption → stronger revenues and GDP

while simultaneously:

Stronger consumption → greater inflation persistence → tighter monetary policy → higher Treasury yields → higher discount rates.

This relationship becomes especially important for long-duration assets.

When Treasury yields rise, the discount rate applied to future corporate cash flows increases. Businesses whose valuations depend heavily on earnings expected many years into the future can therefore experience significant valuation pressure even while the economy remains relatively strong.

That is why MWM continues to emphasize the bond market as one of the most important confirmation mechanisms for the economic thesis.

The Federal Reserve tells us what policymakers are doing.

The Treasury market tells us how financial conditions are absorbing it.

What This Means for Portfolio Management

The current environment argues for greater differentiation between companies.

When inflation, interest rates and input costs are stable, financial conditions can support broad multiple expansion across markets. A more volatile economic regime creates dispersion.

MWM believes investors should pay particular attention to several characteristics.

Pricing power. Can the company increase prices without materially damaging demand?

Gross-margin resilience. Can the business protect profitability as input costs rise?

Free cash flow. Does the company generate sufficient internal cash to finance operations and investment?

Balance-sheet strength. How dependent is the company on refinancing in higher-rate markets?

Capital efficiency. Is management allocating capital productively?

Supply-chain exposure. How vulnerable is the company to transportation, commodity and imported-input disruptions?

Valuation discipline. How much future growth is already embedded in the market price?

These factors become increasingly important when economic resilience and inflation coexist.

What This Means for Businesses

The August report also carries an important message for business owners and corporate leadership teams. Revenue growth alone does not necessarily mean financial conditions are improving.

A company can experience higher sales while simultaneously confronting:

higher inventory costs, higher transportation expenses, higher wages, higher borrowing costs and larger working-capital requirements.That makes financial planning increasingly important.

Leadership teams should be asking:

How much of our revenue growth reflects volume versus price?

What happens to gross margins if input costs rise another 5% or 10%?

How much pricing power do we actually have?

What happens to cash flow if customers begin paying more slowly?

How much additional working capital will higher inventory costs require?

What happens when existing debt must be refinanced?

And how sensitive is our forecast to a meaningful slowdown in consumer demand?

This is where Strategic FP&A becomes especially valuable. The objective is not merely to report what happened last month. It is to understand what happens next under multiple economic scenarios.

Consumer Strength Does Not Mean Consumer Invulnerability

There is another important distinction. Strong aggregate retail sales do not mean every household is financially strong. Different consumer groups can experience the same economic environment very differently.

Higher-income households may benefit from rising financial assets, stronger balance sheets and greater discretionary income. Lower- and middle-income households typically spend larger portions of their income on necessities such as housing, transportation, food and energy. Those households may therefore experience significantly greater pressure from inflation.

This creates the possibility that aggregate consumer spending remains resilient even while financial stress increases underneath the surface.

MWM will therefore continue monitoring not simply retail sales, but also:

consumer credit,

delinquencies,

real wage growth,

personal savings,

employment,

weekly jobless claims,

consumer confidence,

credit-card spending,

and corporate commentary about customer behavior.

Eventually, these indicators will tell us whether consumer resilience is durable—or merely delaying an adjustment.

The MWM Economic-First Interpretation

The August retail-sales report strengthens the case that the U.S. economy retains meaningful underlying demand. But that strength cannot be analyzed independently from inflation.The current transmission mechanism increasingly looks like:

Energy & Supply Pressure

→ Higher Import and Input Costs

→ Higher Corporate Costs

→ Resilient Consumer Demand

→ Greater Ability to Pass Costs Through

→ Persistent Inflation

→ Restrictive Monetary Policy

→ Higher Treasury Yields

→ Higher Cost of Capital

→ Pressure on Corporate Margins and Asset Valuations

The key number from the August report is therefore not simply the 1.2% increase in headline retail sales.

It is the 1.4% increase in the control group.

That tells us underlying consumption remains strong enough that monetary restraint has not yet produced broad demand destruction.

For economic growth, that is encouraging.

For inflation, it is more complicated.

For monetary policy, it may become a problem.

MWM Investment Thesis

The U.S. consumer remains one of the primary pillars supporting economic growth. But consumer resilience is increasingly becoming a double-edged sword.

Strong demand supports revenues, employment and economic activity today.

At the same time, resilient demand can allow rising energy, transportation and input costs to pass more easily through the economy. If that process keeps inflation elevated, monetary policy may have to remain restrictive for longer than markets would otherwise expect.

The sequence MWM is watching is therefore:

Consumer Resilience → Inflation Persistence → Federal Reserve Policy → Treasury Yields → Credit Conditions → Corporate Cash Flows → Asset Valuations.

The question is no longer simply whether the consumer is strong.

The more important question is:

How long can the consumer remain strong before higher prices and higher interest rates finally change behavior?

The answer will have significant implications for the economy, businesses and financial markets.

The economy comes first.

MWM Global Investment ResearchEconomics • Macro Strategy • Equities • Fixed Income • Credit • Capital Markets • Portfolio Strategy