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• What Businesses Are Saying
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Transcript

Tim Sablik: My guests today are Andy Bauer and Renee Halton. Andy is the regional executive for the Baltimore branch of the Richmond Fed, and Renee is the regional executive for Richmond. They both regularly engage with business and community leaders to gather real-time economic information that helps inform the monetary policy-making process. Andy and Renee, welcome back to the show.

Andy Bauer: Thank you, Tim. It's great to be back.

Renee Haltom: Happy to be here, Tim.

Sablik: Your economic sensing, as we like to call it at the Richmond Fed, supplements the aggregate data we get on the economy, which often come in on a lag and can be incomplete or even present some puzzles. One puzzle that's drawn attention in recent months has to do with consumer spending. Inflation has been elevated for a good while now, but despite rising prices, consumer spending has remained strong. Have businesses expressed surprise to you about continued consumer resilience?

Haltom: The strong consumer has been a real puzzle for firms and economists alike this year. Don't get me wrong, firms are thrilled about consumer strength. But we hear a lot of comments along the lines of, "But how long can this last? And when will the consumer pull the ripcord?"

A debt collection firm told me something remarkable, which is that we keep expecting to see a big correction with the American consumer since COVID. But we haven't and we don't really understand where the resilience is coming from.

It's been a surprise to firms for several reasons: the greater economic policy uncertainty in the last couple of years and the perception that the hits keep coming — tariffs, rock-bottom consumer sentiment and, more recently, the surge in gas prices since the conflict in the Middle East began six months ago. In fact, it really surprised us when consumer spending grew faster after gas prices rose, not slower as would normally happen.

Bauer: Yeah, I completely agree with Renee. Everybody's been surprised by the strength of the consumer. Overall, most of the consumer-facing firms that I've spoken with have been expecting some degree of a pullback at some point for all the reasons Renee mentioned.

I'd also add that there was a lot of question regarding the health of the labor market coming into this year. There was, on net, no hiring out outside of health and social services. The strength of the labor market and the consumer was a very live question coming into the year, and then energy prices spiked. But the labor market has proved considerably resilient, with decent job growth this year, and consumer spending has done remarkably well.

Sablik: In what parts of the economy has consumer spending remained strongest?

Bauer: Well, what we hear most is that businesses selling to higher income consumers are doing very well. Demand is very strong in that segment. Upper-income consumers have shown to be less price sensitive. So, while we've heard about pushback from some consumers to higher prices, this has not been the case with higher earners.

I talked with a high-end furniture manufacturer earlier today. Their sales are up double-digits. I asked why he is doing so well, and he simply said that the upper end of the cake tends to do very well.

Another good example is the hotel sector. We talked to a lot of contacts who are in tourism, and they say that higher-end hotels and resorts have seen strong demand, despite the fact that prices in that segment continue to increase. In contrast, they say that there is weakness in the economy segment of the market.

Haltom: I totally agree with Andy. There is a common thread you hear among firms, which is that post-pandemic, people are focused on experiences and living a good life. It's like the pandemic made us ask what life is for, so they want to visit their families and go to the concert. What living a good life means differs by consumer, but you're seeing people pick the categories of spend that are most important to them and then cutting back on other things.

This raises a natural question. Contacts frequently ask us, "Well, is all the spending just fueled by a debt binge? Is it happening on credit cards and the like?" That doesn't seem to be true either, at least in the aggregate. Consumer debt service as a share of income is historically low. Banks continue to tell us that credit quality is excellent and delinquencies have not risen to concerning levels.

Sablik: Yeah, I want to dig in a little bit more on what Andy was talking about with this divergent spending with different income groups.

We recently did an episode about the K-shaped economy, which is an argument that consumption patterns have diverged for higher-income — the upper arm of the K — versus lower-income households — the lower arm of the K. Have you heard anything else from businesses that might shed some light on that possibility?

Haltom: Yes, Tim. We hear about the K-shaped economy almost everywhere we go. Firms openly talk about it.

What Urvi's research showed on the episode you mentioned is that it's a bit of a misnomer that the lower-income segment is getting actively worse off. They actually are not.

But there are absolutely spending differences among the high end and the low end, with the lower end continuing to spend but having to make hard choices to make that spending work. The result is that if you're a business that caters to lower-income groups, you see more consumer price sensitivity and, in some cases, pullback in the ways Andy mentioned. You're seeing more signs of consumer strain, whether that's defaults or delinquencies. Conversely, the luxury segment is doing very well, especially for experiences.

There's two nuances I'll add to this. One is that we're hearing anecdotally that some households within the lower-income segment absolutely are getting worse off. So we never want to ignore or discount that. We're hearing from philanthropy, from food banks, from nonprofits that need is increasing at the very lowest end, especially if you've had a shock like job loss or a loss of benefits like SNAP. So, on balance, low-income households are still consuming more. But there are exceptions that anecdotally seem to be rising, even if it doesn't register on the macroeconomic level.

Second, we're hearing from contacts, especially in banking and similar sectors, that the K-shaped consumption may have alleviated some more recently. If you look at daily credit card spend data, spending patterns for both high-income and low-income groups has been strong throughout the summer. They're actually converging. Part of this could be moments when gas prices receded and shorter-term phenomenon like that, or perhaps it's partly that consumer creativity has amped up over the summer in terms of how they're making the spend work.

Bauer: I think Renee covered this quite well. Many firms talk about the K-shaped economy; they are seeing different behaviors. But it isn't necessarily that a large segment of the consumer base is getting worse off. I just think this is how they're thinking about their different segments of the consumers that they cater to.

One contact that I spoke with described the economy as more like an E, with high-end consumers doing very well, middle consumers holding their own, and low-income consumers struggling. That wasn't necessarily the case that lower-income consumers were regressively getting worse off. He was just noting the differences in behaviors amongst his customer base.

I think what's important isn't necessarily the letter we are using to describe things, but just the acknowledgement, understanding that the experience of consumers varies considerably in this economy.

Sablik: You've both touched on this a little bit in our conversation, and it's the crux of the puzzle we've been discussing. Have businesses shared any insights into exactly how households might be coping with rising prices?

Bauer: We have heard a variety of strategies. What I hear most is that consumers are making different choices and ultimately are looking for greater value.

You hear this a lot when speaking with grocery stores and with restaurants, for example. With grocery stores, there is a "protein waterfall" — as prices rise and consumers feel their pocketbook increasingly pinched, they will trade down from one protein to another, from beef to chicken to pork to hot dogs and beans. They will also move from brand name to generic.

In restaurants, we hear that there are less appetizers or desserts being ordered, or they're more likely to share entrees. I was in West Virginia last week and a restaurant owner said that she sees more families come in and share a pizza instead of everyone getting their own entree.

Another strategy is borrowing from the future. We have seen a rise in "buy now, pay later," and not just for goods. We're seeing this type of borrowing to support payments for services such as car repairs.

Consumers are increasingly repairing autos rather than making new purchases. We have heard from auto dealers that consumers are holding off on that big new car purchase, choosing to make repairs instead.

I'd also mention one other strategy, which is to forego paying for health insurance. In some cases, we hear that consumers are rolling the dice and going without health insurance. Of course, this frees up income to maintain spending currently, but that just could be borrowing from the future should a health issue ultimately arise.

Haltom: Yeah, Andy did a great job describing the trade-down effect that we've been seeing. There's a couple of other strategies we're hearing that are sometimes hard to see in the data.

A version of this is strategic use of credit. Consumers might rotate the bills they're paying — paying some [but] never quite going delinquent — in order to free up spending for other things. We're also hearing increasing stories that products like buy now, pay later, as Andy said, is helping to fund that kind of creative cash flow and increasingly being used to purchase necessities like groceries. That might make the spending work, but it also introduces the possibility of very thin margins of error for consumers, so that's something to watch going forward.

Another strategy has been finding additional sources of income. One is gig work or second jobs, which can be harder to see in the jobs data, depending what data you're looking at. New research that just came out from our colleagues Urvi and Kyle DeMaria show that the share of Americans holding multiple jobs hit a peak in late 2025, and the increase is concentrated among middle-income families.

I'm also hearing a lot of contacts talk about generational gifts. That could look like moving in with one's parents, which of course frees up housing costs for other sorts of spend.

I'm also hearing a lot of anecdotal stories about boomer-aged parents supplementing the spend of younger households. When we talk with firms, they either are experiencing it themselves, or they're hearing about that from their employees, and they're openly wondering how much that sort of behavior is helping to prop up the spend of their customers.

Sablik: Has the picture of consumer health that you're getting from businesses changed a lot since the beginning of this year?

Bauer: Yes, I would say that it has. As I mentioned, there were questions coming into this year about consumers, the labor market, generally the economy overall. Then, the energy price spike hit. The resilience of the consumer over the past six months has given greater confidence to everyone that consumers are able to navigate this economy, even with rising prices for some goods and services.

At the same time, there's greater confidence in the labor market. We've seen stronger job growth across a greater number of sectors so far this year than we did last year. A strong labor market should support healthy consumer spending going forward.

Now, still, we continue to watch those segments that are most at risk. But overall, I think the outlook for the consumer and the broader economy is much better than where we were at the beginning of the year.

Haltom: Yeah, I agree with Andy that the consumer outlook has firmed and broadened, but the high level of prices is still present. You do still hear firms asking the question of how long can consumer creativity go on. So, even if the consumer seems strong today, there is this question of will that remain in the future.

Firms do still very much see consumers making trade-offs. They have to be careful about when and where to raise prices, which is of course what we're thinking about when it comes to Fed policy. For example, when I talk with firms that make consumer technology gadgets, they see consumers pushing off those big purchases, and so they are more cautious about 2027.

Sablik: On that note, what are businesses saying about their expectations for future price increases through the rest of this year and into 2027?

Haltom: Well, as you might imagine, that's the question of the moment, and so we've spent a lot of time in the last several weeks looking into this. As firms enter their 2027 budget cycles, we're asking firms, "What are you anticipating for costs and for prices, and to what extent do you think you'll be able to pass prices through?"

A couple of new things have emerged in recent weeks that feel different from earlier this year. One is that renewed cost pressures are starting to feel ubiquitous among firms, whether it's diesel or land or energy or skilled labor or equipment or software. Healthcare insurance is a big one heading into 2027, with many firms citing double-digit increases. So there's a long list of costs that firms are citing right now that feel like they're on the increase.

One could argue that that's a bunch of individual shocks in those cost verticals and not broad-based inflation. But then when there's a long list of them, that starts to feel like a distinction without a difference.

Second, business-to-business firms are more confident of passing on costs than businesses that serve consumers. But many firms, both on the B2B side and the B2C side, are very conscious of limits to their pricing power right now. In some cases, they know they'll lose volume if they raise prices further, but they're okay with that trade-off because they need to restore margins. In other cases, they're going to absorb some price increases and make up the difference with productivity if they can, which is helpful for firms because productivity has been strong. So it does feel to us like a continued elevated inflation environment, though I hear a number of firms saying, "But it's not 2022 when inflation was at a 40-year high."

Bauer: Renee has that exactly right. We still hear about costs. We still hear about margin pressures. Given this environment, it's more difficult to see pricing coming down to something at a pre-COVID level.

In addition, pricing decisions for some firms changed during COVID. They figured out that the prior pricing strategy was not their best strategy, and so they do things a little bit differently. We hear this in the hotel sector and other services.

We also hear from firms that they have greater confidence, and so they're more likely to increase prices now when they have a cost increase than they were in the past. Just as an example, the furniture manufacturer I spoke with, prior to COVID, they just took perpetual deflation because furniture was a very difficult business. They tried to offset weak pricing with productivity gains. During COVID, they realized that people really like their product and that they could handle a certain amount of price increase. Going forward, they're actually increasing prices for their products, whereas in the past they were just taking perpetual price deflation.

Others are really feeling the pressure to keep price increases modest, as they are concerned about losing demand. For us going forward, we will continue to be in contact with firms to see how all of this nets out.

Haltom: Andy just made a really interesting point, which is that firms learned a lot in the last five years or so about how to raise prices again. In some cases they're using newer technology to do that. I was talking with a manufacturer yesterday who talked about these different strategies that they learned about, with more precision, where they can raise prices. It's no longer as connected to costs are going up here, so I'm raising prices in that same place. They've learned instead a greater ability to raise prices in other areas of their business in a way that compensates for rising costs.

Bauer: Renee, I think that's exactly right. Firms see that there are opportunities to increase prices, and so they're making investments to make sure that they have the optimal pricing strategy. Going back to this manufacturer, I asked, "Well, how much you increasing your prices for going forward? And he said, "Right now, it's just an average price increase. I really don't have a good handle on my costs. So we're going to invest in technology to have a better handle on my costs for all my different production lines, so that I can have a better pricing strategy going forward."

And so, because of the experience of COVID, because of technology, and the ability to raise price, firms are being a little bit more thoughtful about how, where, and how much they can raise prices going forward.

Sablik: Thinking about your own economic sensing over the next few months, what are the key questions about consumer health that you'll be asking that you'll be focused on?

Bauer: Obviously, the key issue will be whether consumers will be able to maintain this level of spending without any negative consequences. Renee mentioned earlier they're being very creative, but what if that creativity runs out?

When I'm thinking about negative consequences, I'm really thinking about excessive borrowing, which could lead to financial distress and defaults. We haven't seen that yet. We often speak with financial firms to get a sense of the financial health of their customers. So far, we've heard of juggling of payments, what to pay and when. Definitely a sign of stress, but not anything that would indicate a sharp deterioration, which would impact spending on a more aggregate level.

Haltom: Yeah, I totally agree with Andy on that. On the firm side, a key thing that businesses are watching is the extent to which consumers will accept price increases. Firms are really watching that to understand how much costs they can push through. On the consumer side, consumers can only borrow from the future for so long. So, in other words, the question is, "To what extent can consumers keep being creative?"

Sablik: Well, Andy and Renee, thanks as always for joining me to share what you're learning from businesses in our district.