Why consumers are still spending in the face of soaring inflation

·Editor focused on markets and the economy

Thu, Nov 18, 2021, 3:09 AM4 min read

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Thursday, November 18, 2021

A link between fatter paychecks, bargain hunting and plastic

It’s common knowledge that inflation is eating away at consumers' ability to spend, as the most basic necessities like groceries and energy extend a relentless spike.

Less understood, however, is exactly why consumers keep opening their wallets as prices climb, even though sentiment indicators show them in a rather glum mood. Growth is slowing and the supply chain crisis has made goods and services increasingly scarce (even if demand and available jobs are certainly not).

This week, Deutsche Bank analysts dissected the management commentary from a range of third quarter earnings calls. And while corporate America clearly voiced concerns over inflation, the transcripts revealed something that’s arguably more compelling — and a point the Morning Brief touched on in Tuesday’s edition.

Binky Chadha canvassed Q3 remarks and found that not only companies are comfortable hiking prices, but consumers appear to be rather placidly paying for them. For example, both UPS (UPS) and FedEx (FDX) boasted of a “very favorable pricing environment” amid implacable demand.

More tellingly, Pepsi (PEP) executives told investors that “elasticity to pricing has been better than we had initially [estimated] in our models,” while McDonald’s (MCD) found higher prices “have been pretty well received by customers.”

Deutsche’s Jim Reid surmises that while “inflation has been a big theme of Q3 reporting... companies generally feel confident in their ability to pass it on.”

Deutsche Bank found there's a run on inflation mentions during Q3 earnings calls, reflecting pressures in the economy. (Deutsche Bank, FactSet)

Which leads us to today’s $64,000 question: Why do consumers appear so comfortable with high prices?

One answer is they’re clearly earning more: Data from the Economic Policy Institute shows a "V-shaped" wage curve that began in April 2021 has translated into a near 5% year-over-year jump in average hourly earnings. But most, if not all, of that money is being eaten up by spiking prices (over 6%, as per the latest consumer price index figures) across sectors and products.

Yet the data suggest consumers are doing what they’ve always done, which is adapt to changing circumstances. Another possible explanatory variable is the prevalence of discount shopping.

On Wednesday, Yahoo Finance’s Aarthi Swaminaman reported that discount retailers like Dollar Tree (DLTR), Dollar General (DG), and Five Below (FIVE) have seen a whopping 65% surge this year compared to 2019, according to data from credit tracking firm Facteus. Meanwhile, both Target (TGT) and Walmart’s (WMT) Q3 earnings were boosted in part by bargain-hunting shoppers looking for rock-bottom prices.

The other factor involves the age-old conundrum of an economy that’s mostly powered by consumer spending. When in doubt about whether you can afford something, just charge it.

Reacting to October’s surprisingly strong retail sales report, Bankrate.com senior industry analyst Ted Rossman wondered aloud “where all of this money is coming from,” especially with stimulus checks being “a distant memory at this point, and yet people continue to spend like crazy.”

Higher wages, stock prices and home values are a part of the splurge, but Rossman also put his finger on something very important — namely consumer debt, which Federal Reserve data showed skyrocketed by 8.3% in September.

“But all of this spending has to translate into higher credit card debt at some point. That’s a trend that we’re seeing among some households, but just beginning to see more broadly. It’s no wonder that we’re dealing with supply chain shortages and inflation because demand is incredibly high right now,” the analyst noted.

It also explains in part the explosive growth of ‘buy now, pay later’ (BNPL) options (also covered recently by Yahoo Finance’s Swaminathan), a 21st century version of department store layaway utilized by those of us who saw our working class parents and grandparents tap those credit lines, especially around the holidays. The BNPL boom is being popularized by Affirm (AFRM), Klarna, Zilch, AfterPay and PayPal (PYPL).

Recently, a Bank of America survey yielded some interesting insight into the increasingly heavy use of BNPL, finding that 47% are funding installments with debit cards and bank transfers, and over half have never made a late payment.

Still, the data showed some red flags: 24% said they turned to BNPL because they were maxed out on credit cards — double the number of respondents in BofA’s prior survey in May. “These data points suggest BNPL providers need to maintain vigilance regarding delinquency risk.”

Indeed. It suggests there’s another potentially inflated bubble at risk of bursting if demand suddenly falls short.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek