Fed’s new challenge: Spend-happy consumers

The shift to working from home, along with wealthy, profligate retirees, is altering U.S. consumer spending patterns and complicating the U.S. Federal Reserve Board’s challenge of combating inflation, says CIBC World Markets Inc.

In a new report, a pair of the bank’s economists say spending trends have shifted permanently in the wake of the pandemic, which forced many workers out of the office while also boosting the wealth of the baby boomers.

“Four years on from the pandemic, there is enough evidence that American spending patterns are not going to revert to pre-pandemic norms,” it said. “The consumer strength seen in 2023 was enough proof for us that the long-awaited rotation from goods to services is not happening.”

The demand for goods has remained robust as workers increasingly stayed at home and spent more on products such as computers, sporting equipment and cookware, the report noted.

“More time for leisure and at home meant greater wear-and-tear on those items, so Americans were replacing, as well as trying out, more types of goods more often,” it said.

Many households are spending more and saving less than they have historically — particularly baby boomers, the report said.

“Boomers collectively represent about one-fifth of the population, but account for an outsized roughly 50% of net worth,” it said, and a greater share of their wealth is in financial assets (equities and investment funds).

“That has proved to be a much bigger tailwind for consumption than expected,” the report said, as retirees have experienced a surge in dividend income, and they’ve proven much more willing to spend that income than previous generations.

These shifts in consumption trends have complicated the challenge for the U.S. central bank.

“The chances of returning to the ultra-low goods inflation era that was seen over the post–financial crisis period seems lower,” the report said. “And durable goods demand has been less responsive to interest-rate changes since it is tied more closely to [work from home].”

Higher rates aren’t acting as quickly and directly on households as they have in the past, but eventually, interest rates that stay higher for longer will slow the economy.

“A higher-for-longer rate environment will increasingly impact businesses, and that will continue to curb wage growth and spending power,” the report said.

“Consumers too, will run out of gas after filling up their houses with gadgets and having one too many streaming subscriptions, while wealthy retirees will eventually have to curtail their spending, as wealth is being drawn down rapidly for near-term consumption, and income tied to the stock market is no longer soaring,” the report said.

Ultimately, CIBC’s economists expect consumption growth to slow modestly this year, which will give the Fed space to cut rates a couple of times.

Longer term, “the new reality is that the U.S. economy is more vulnerable to supply shocks than before the pandemic, and the Fed will have to adapt its tools to account for the shift in preferences of the consumer,” it said.