As speculation swirls around the Federal Reserve’s potential adjustment of interest rates from a 23-year high, indications of strain within the consumer sector are surfacing, prompting concerns about the implications for the stock market if these trends persist.
At the onset of 2024, investors were braced for approximately six quarter-percentage-point rate cuts, with expectations of implementation as soon as March. However, these anticipations underwent significant revision in response to stubborn inflationary pressures, a labor market characterized by tightness, and other economic indicators that pointed to resilience rather than faltering. Consequently, the current consensus among investors is more modest, with expectations now centering around two to three rate cuts, tentatively scheduled for the autumn.
Despite experiencing a setback in April, stock prices have largely weathered the storm, with investors maintaining a degree of optimism buoyed by the belief in a robust economy and a consumer base capable of driving profit growth. However, recent reports have hinted at a discernible shift in consumer behavior towards more discerning spending habits. This shift is evident in lackluster sales growth reported by several prominent companies in the food and beverage sector, including McDonald’s, Shake Shack, Wendy’s, Starbucks, and KFC parent Yum Brands.
Mace McCain, Chief Investment Officer at Frost Investment Advisors, underscores the importance of monitoring consumer spending patterns, particularly in relation to income growth. While consumer incomes and spending continue to trend upward, there are indications that spending is outpacing income growth, suggesting the potential for financial strain among households. Of particular concern is the possibility of rising unemployment and job insecurity, which could prompt consumers to exercise caution and reduce discretionary spending, thereby dampening economic growth.
Recent economic data, including weaker-than-expected U.S. jobs growth in April, paints a picture of modest labor market weakness. Despite this, the stock market rallied as investors embraced a “Goldilocks” scenario, characterized by economic conditions that are neither too hot nor too cold, aligning with the Federal Reserve’s objectives.
Gregory Daco, Chief Economist at EY, views the jobs report as encouraging, citing a rebalancing in labor market conditions, moderate labor demand, historically low employment rates, and cooling wage growth. Such a scenario may provide the Federal Reserve with the necessary conditions to proceed with rate cuts.
While the strain on consumers has affected certain companies, particularly those catering to lower-income demographics, its impact on the broader stock market remains muted. Richard Flax, Chief Investment Officer at Moneyfarm, highlights the disparities in economic impact across different income cohorts, with lower-income consumers bearing the brunt of the strain.
Looking ahead, investors will closely monitor comments from Federal Reserve officials and key economic data releases, including wholesale inventories, weekly initial jobless claims, and consumer sentiment figures. These developments will offer valuable insights into the trajectory of interest rates and the overall health of the economy, informing investment decisions in the coming months.
