- July’s PCE report showed consumers spending resiliently, with inflation matching expectations. But beneath the surface, there was a pullback in spending in discretionary categories—a bad sign when combined with last month’s weak job growth.
On paper, the July personal income and outlays report on Friday looked solid. Personal income rose 0.4% on a monthly basis, spending increased 0.5%, and the Fed’s preferred inflation gauge—the core PCE (personal consumption expenditures) price index—climbed 0.2% as expected. Taken at face value, it’s the picture of a consumer still propping up the economy, despite the cloud of uncertainty from tariffs and weaker jobs growth.
But scratch beneath the surface, and some cracks start to show.
Wells Fargo economists noted that July’s spending growth masked a pullback in discretionary categories like food services and hotel accommodations.
“We have argued that one largely unnoticed early manifestation of tariff impact on consumer spending is the trend decline in discretionary services categories,” the bank wrote.
The bank added later that while cutting back on eating out and hotel stays doesn’t “signal disaster,” it paints a picture of the sorts of decisions households make while under price pressure.
Preston Caldwell, chief U.S. economist at Morningstar, similarly pointed out that year-over-year spending growth has decelerated to 2.2%, from 3.1% at the end of 2024.
Services have driven the slowdown, while goods spending has held steady, likely because households are “stocking up on goods in anticipation of future tariff-driven price hikes.”
“Today’s PCE data supports a picture of the U.S. economy that is moving in a more stagflationary direction (lower growth, higher inflation), albeit slowly,” he said in a note, adding that core inflation is trending up again, as tariffs are likely driving up goods prices.
Claudia Sahm, a former Fed economist and creator of the Sahm Rule recession indicator, also noted that inflation is clearly drifting in the wrong direction.
Sahm told Fortune the Fed will “look through” the temporary inflation bump from tariffs, but she worries that sticky service sector prices are heating up on their own. At the same time, she flagged the labor market as the more pressing risk.
“Job growth really slowed down,” she said. “And there are certain groups on the margins of the labor market that are having a much harder time—that’s what we tend to see before things get broadly worse.”
That tension between consumers spending resiliently despite fragile job growth is the thread running through the July data. Consumers are still willing to open their wallets, but just barely. Spending grew faster than incomes, eating into savings, and much of it came from necessities rather than luxuries.
Jennifer Lee, a senior economist at BMO, pointed to a surprise rebound in wages and salaries, which were up 0.6% in July after a milquetoast 0.1% in June, as evidence that consumers still have some cushion.
“We should never underestimate the U.S. consumer,” she told Fortune. “It’s a good start to the third quarter. But it does make life a little bit more difficult for the Federal Reserve.”
Even so, Lee said Fed Chair Jerome Powell has decisively shifted focus.
“He’s more worried now about jobs than inflation,” she said. “The indications of slower job growth, I think, will be enough for him to cut rates 25 basis points on September 17.”
Wells Fargo noted that for now, income is still outpacing climbing prices, but a slowing job market could derail that.
“Real disposable personal income rose 0.2% in July. It will take a sturdy labor market to sustain that sort of income growth, and we have our doubts about that,” the bank wrote.
That leaves the consumer in a double bind: still resilient, but increasingly forced to be discerning, particularly in a world where prices perniciously creep up.
Sahm warned that if tariffs and weak job growth persist, today’s resilience could turn into tomorrow’s retrenchment.
“There are real risks that inflation gets embedded above target,” she said. “And there are real signs that the labor market is softening. That’s not an easy setup.”
