The Consumer Engine Is Still Running – But for How Long?

Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast

After a long drought of government economic releases, we finally got a key update last week: the Consumer Price Index (CPI) from the Bureau of Labor Statistics. The report came a little later than usual because of the government shutdown, but it was important enough to call BLS staff back to work to calculate the annual cost-of-living adjustment for Social Security recipients.

Inflation inched up slightly from the prior month, with the annual rate rising back to 3%. That was a bit less than expected, and Wall Street celebrated. The Dow surged nearly 500 points on the day, as investors bet that the softer inflation data boosted the odds of a Federal Reserve rate cut next week. The probability of an October cut now sits near 100%, and markets are also pricing in another cut by December with odds above 90%.

With the shutdown delaying federal releases, labor-market data have been limited. The most recent ADP report (a private sector employment report) showed national payrolls declining in September, and the August figures were revised down from a modest gain of 54,000 jobs to a small loss of 3,000. While ADP and BLS numbers often diverge, if this pattern holds when the next BLS report eventually appears, it would point to a labor market beginning to feel some strain.

Why does the labor market matter so much for growth? As we’ve noted before, consumers account for roughly 70% of the U.S. economy—and they’ve carried an outsized share of that growth recently. In three recent quarters, consumer spending contributed more to GDP than overall economic growth itself, meaning that without strong consumer spending, GDP would have been much weaker. Any disruption to that engine, particularly from a softening labor market, could spell trouble for the broader economy.

Consumer sentiment, meanwhile, has been mired in pessimism since inflation reappeared in 2022. Yet despite complaining about higher prices, consumers have kept spending. Strong stock-market gains and rising home equity have boosted household wealth, creating tailwinds for spending. The labor market also provided confidence, at least until recently, when job openings far exceeded the number of unemployed workers. That gap has now closed, and the number of unemployed has overtaken total job openings for the first time in several years.

While layoffs remain relatively modest, job growth has clearly slowed. We’re no longer seeing the robust hiring of a year or two ago, and recent indicators even suggest the possibility of job declines.  That’s significant, because inflation didn’t stop consumers from spending, but the fear of job loss will.

The story of the past year has been one of remarkable consumer resilience. But resilience has its limits. If the labor market weakens further, it could finally cool the consumer engine that has kept the economy humming. The next few months will reveal whether the Fed’s anticipated rate cuts arrive in time to cushion the landing, or if consumers start to tap the brakes.