Dive Brief:

• Consumers expect to sustain their spending well above prior forecasts even as the surge in interest rates from near zero threatens to erode their financial footing, according to research by the Federal Reserve Bank of New York published Wednesday.
• “Households report solid and stable expectations for spending growth, consistent with our evidence on the strength and liquidity of household balance sheets, including relatively low delinquencies,” the Fed economists said.
• “Of course the period of very low interest rates that supported many of these developments is decidedly over, at least for now, suggesting that household finances will likely tighten further in the coming months,” the researchers said.

Dive Insight:

The Fed study highlighting consumer expectations for sustained spending aligns with a second central bank report showing that household median net worth soared 37% between 2019 and 2022 after adjusting for inflation.

Increasing home prices, rising stock markets and federal aid during the pandemic fueled the biggest three-year gain in household wealth since the start of a data series in 1989, the Fed said Wednesday in its Survey of Consumer Finances.

Consumers, who generate nearly 70% of economic growth, used widespread loan forbearance during the pandemic to reduce debt and increase savings, the New York Fed economists said. Their spending “has surprised to the upside, especially in 2023.”

Spending at stores, online and at restaurants increased a better-than-expected 0.7% last month compared to August, the Census Bureau reported Tuesday while marking up its estimates for July and August. During the third quarter retail sales ballooned at an 8.4% annual rate.

“Yesterday’s September retail sales data indicate continued strong spending,” Fed Governor Christopher Waller said Wednesday in a speech. “While household spending has been volatile, smoothing it out over the past several quarters indicates underlying momentum.”

“I have been waiting a while for tightening financial conditions to cause a significant slowing of spending, and I have been consistently surprised at the resilience of consumer spending,” he said.

Manufacturing, hiring and economic growth have also blown away expectations, prompting Fed staff and many other economists to scuttle predictions of recession this year. Wage gains have slowed in 2023 but exceeded inflation, while unemployment of only 3.8% underscores persistent high demand for workers.

“It seems clear that economic activity was substantially higher for July through September than earlier in the year,” Waller said.

Gross domestic product during the third quarter probably rose at a 5.4% annual rate, the Atlanta Fed said Wednesday, increasing its estimate from 4.9% on Oct. 5.

“Many forecasters in the past few months have abandoned their projections of recession and negative consumption growth,” the New York Fed economists said, noting that excess savings built up during the pandemic has helped fuel sustained economic growth.

“There is tremendous uncertainty, however, about how much excess savings still remain in the household sector,” they said, adding that rising borrowing costs may prompt a pullback in spending.

The Fed, pursuing its most aggressive tightening in four decades, has pushed up the federal funds rate to the highest level in 22 years. Meanwhile, the yield on the 10-year Treasury note, the benchmark for corporate and other borrowing, rose Wednesday to about 4.9%, a percentage point higher than at the start of July.

“Financial conditions have tightened significantly since July,” Waller said, echoing comments this month by several policymakers including Fed Vice Chair Philip Jefferson.

Yet mounting borrowing costs may have little or no impact on short-term growth, according to the Beige Book, a summary of reports on the economy from the Fed’s 12 regional banks released on Wednesday.

“The near-term outlook for the economy was generally described as stable or having slightly weaker growth,” according to the report, released two weeks before a scheduled meeting of policymakers.