"Strong on the outside, weak on the inside" American consumption?

This year, the most perplexing aspect of American economic research may be the significant changes in Trump's policies that we have diligently tracked for over half a year, yet the data shows American inflation remains calm, the economy is "struggling" to slow down, and the U.S. stock market has reached historical highs. As we approach August 1st, the "Tariff 2.0" smoke is rising again, and Trump seems to be even more "confident" and at ease, because up to now, the "soft landing" data really gives him "confidence," but has the narrative of "stagflation" really been put aside?

In fact, in June, the transmission of tariffs began to subtly appear in the data, but consumer spending showed an unusually strong resilience. Especially in durable goods consumption represented by automobiles: Trump's uncertain policies seem to have led to a superficial prosperity in American automobile consumption characterized by "price for volume," which is somewhat counterintuitive. Moreover, it is worth noting that the U.S. industry is experiencing a clear divergence, with manufacturing shrinking while the service sector is soaring.

Where exactly is the problem? How can we systematically assess demand and policies for the second half of the year?

In the first half of this year, American consumption involved both "grabbing" and "waiting." For consumption in the first half of the year, stockpiling before the tariff imposition is indeed the most logical speculation, but from a micro perspective, it is also understandable that there are situations of controlling/reducing consumption due to policy uncertainty.

Goods are clearly in "grabbing," while services are more in "waiting." From the perspective of demand looking at supply, this corresponds to the upward trend in U.S. manufacturing at the beginning of this year, while the service sector weakened; on the other hand, since June, the rebound in consumer confidence has gradually led to a retreat from "grabbing" consumption and a replenishment of "waiting" consumption—manufacturing enterprises may face the issue of destocking, while service enterprises may further recover.

Looking further into the details, the most prominent "grabbing" consumption in goods is automobiles; while the most typical "waiting" consumption in services includes transportation, leisure, and accommodation. Before the escalation of tariff frictions from the end of last year to April and May this year, there was indeed a certain degree of stockpiling and consumption grabbing by enterprises and residents, but in months with significant uncertainty (April and May being typical), many residents chose to "tighten their belts" and wait and see.

From the consumption data after excluding price factors, the overdrawn nature of American consumption is mainly reflected in durable goods represented by automobiles; additionally, clothing, hosiery, and home appliances also saw some consumption grabbing, but leisure goods were notably weak. Therefore, we see that in the second quarter of this year, retail companies focused on essential consumption and supply chain services in the U.S. stock market, such as Walmart and Costco, performed well

And services and other consumer goods either show no obvious overdraft or there is insufficient consumption. Especially in an uncertain policy environment, residents seem to have temporarily chosen to reduce leisure, travel, and dining out. This is also reflected in United Airlines' Q2 financial report, where, although Q2 revenue was good, net profit fell by 26% year-on-year, mainly due to weak domestic leisure demand and ticket price competition—total revenue per available seat mile decreased from 18.81 cents to 18.06 cents year-on-year in Q2 (a decrease of 4%).

Looking ahead to the second half of the year, we analyze the strongest automotive consumption in the first half as a representative of commodity demand prospects, and maintaining the same high level in the second half will not be easy. Although automotive retail remained hot in June, we hold a pessimistic view on automotive sales in the second half, as overdrafts will eventually face repayment unless the Federal Reserve aggressively cuts interest rates. Our reasons mainly focus on three aspects:

First, on the supply side, automakers' "price for volume" strategy is not a long-term solution. A rather strange data point in U.S. consumption for June is that automotive retail significantly exceeded expectations, but car prices are accelerating downward. The situation of automakers/dealers exchanging price for volume is still quite evident: on one hand, from a macro perspective, according to Kelly Blue Book data, the average transaction price of new cars from mainstream manufacturers in the U.S. in June was $48,907, while the average manufacturer's suggested retail price (MSRP) rose for the third consecutive month to $51,124, indicating that manufacturers are bearing more of the tariff impact; on the other hand, a major U.S. automaker, General Motors, saw a 7% year-on-year increase in North American market sales in Q2, but revenue fell by 2.5% year-on-year, and EBIT profit margin dropped from 10.9% to 6.1%, with direct losses from tariffs amounting to $1.1 billion Looking ahead, as manufacturers gradually raise prices and the termination of tax breaks for electric vehicles, automobile consumption is likely to experience a repayment-style decline. There is a limit to how much loss automobile manufacturers can bear; as the United States signs agreements with more and more economies, the tariffs faced by automobiles will be definitively established, and this transmission will inevitably occur gradually; moreover, the tax reduction bill passed and signed by the U.S. Congress on July 4 will terminate the tax credits for purchasing new and used electric vehicles on September 30, which will undoubtedly have an additional impact on electric vehicle sales (which accounted for 20% of total new car and truck sales in the U.S. in 2024).

Secondly, on the demand side, there may be extreme wealth disparity in U.S. automobile consumption. In the U.S., cars are a "rich man's game," with the top 30% of households accounting for as much as 78.4% of all major consumer goods.

After the tariff shock, although consumer sentiment and confidence in the U.S. have shown a significant recovery, specifically, the wealthy are clearly more optimistic, while low-income groups remain full of doubts. The saying "the rich feast while the poor freeze" may be just that. And it is relatively difficult for the entire automobile sales to be elevated by relying solely on the wealthiest households.

Additionally, it is worth noting that interest rates are one of the important considerations for U.S. residents when purchasing cars this round. In fact, a closer look reveals that this round of durable goods consumption, represented by automobiles, has actually overdrawn twice: the first round is at the end of 2024, driven by expectations of policy easing and tariffs (both real estate and automobile consumption rising simultaneously, with real estate sales being more sensitive to interest rates); in contrast, the second round of overdraw occurred in the first quarter of this year, especially in March, mainly due to consumption driven by tariffs: compared to the first round, real estate sales have not shown much improvement. Therefore, the repayment of the overdrawn amount depends not only on tariffs but also on interest rates. The likelihood of the stubborn Federal Reserve Chairman Jerome Powell emulating last year and even more aggressively cutting interest rates in the second half of this year is low.

By observing the subtle signs, the combination of demand overdraw + high inventory will lead to a continued contraction in U.S. manufacturing for a period of time in the second half of the year. In addition to the aforementioned demand overdraw issue, as the previously rushed imports dock and unload, the inventory of enterprises/traders showed a significant increase in June. This means that for a period of time in the future, U.S. manufacturing will enter a relatively de-inventory phase The most intuitive reflection in the data may be that the PMI continues to remain below the boom-bust line of 50%, and the upward pressure on certain commodity prices is weak, further hindering the transmission of tariffs to consumers.

As for service consumption, there are at least two points of understanding: first, unlike goods, most services do not have so-called retaliatory consumption and overdraft due to their immediacy, but rather return to normal levels from previous consumption shortages. Therefore, its elasticity and fluctuation are not comparable to that of goods consumption. Secondly, the expansion of the service industry amid manufacturing contraction may not be a sufficient reason for not easing, as seen from the experience of the second half of last year, the contraction of manufacturing is more conducive to controlling inflation, and the Federal Reserve still chose to unexpectedly cut interest rates by 50bps in September.

Therefore, although the current U.S. economy seems so fragmented and complex, we still believe that the current combination of manufacturing and services can lower the economic threshold for the Federal Reserve to cut interest rates in the second half of the year, especially under the circumstances of controllable inflation and potential employment risks, coupled with political pressure from the White House, the probability of a rate cut in September is considerable, significantly higher than 50%.

However, for the Federal Reserve, the most challenging part may be after restarting interest rate cuts. We tend to believe that the Federal Reserve will not cut rates linearly and continuously, but is more likely to cut rates quarterly. From the repetitiveness of Trump's tariffs and the historical stubbornness of inflation, if it wants to avoid inflation "returning" in the fourth quarter, the Federal Reserve must control the magnitude and pace of rate cuts—initially cutting rates slightly and quarterly may be a compromise that Powell can accept.

In reality, slow and small rate cuts cannot provide a particularly strong environment for the use of the U.S. debt ceiling, and it may still be difficult to ease fiscal policy within the fiscal year. Referring to Europe, which has not seen a significant recovery after gradually cutting high interest rates since last year, without fiscal cooperation, monetary policy alone is insufficient, and it is challenging for demand to continue to recover.

Authors of this article: Shao Xiang, Wu Shuo, Lin Yan, Source: Chuan Yue Global Macro, Original title: "Elusive Demand (I): Is U.S. Consumption 'Strong Outside but Weak Inside'? (Minsheng Macro Shao Xiang)"

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