US consumers brace for the energy price-rate hike squeeze

US consumers, already squeezed by nearly a year of high inflation, are facing new headwinds in the form of a surge in energy prices, and now a likely much steeper rise in interest rates. The US is largely insulated from the risk of energy supply disruptions faced by Europe resulting from the Russia-Ukraine conflict, as it is mostly energy independent. However, it is vulnerable to some of global price shock effects. In particular, gasoline prices move much more in sync with global oil prices in the US, given the lower component of energy taxes embedded in prices. As a result, pump prices have surged 18% just over the past month alone – the biggest monthly rise since at least the aftermath of the global financial crisis, when oil prices were rebounding from much lower levels. Households will be spared some of the pain European households face from higher utility gas prices and home heating costs, as US natural gas prices have not risen to anywhere near the same extent as in Europe. However, the hit from higher gasoline prices is still big enough to represent a large negative real income shock. On the back of this, and in contrast to producer sentiment (which according to the latest PMIs is holding up for the time being), March saw a further plunge in consumer confidence, which had already fallen on the back of more broadly elevated inflation over the past year; confidence is now by some measures even lower than during the 2020 downturn.

We expect the hit to real incomes and confidence to result in weaker consumption growth this year and next, and have significantly downgraded our GDP growth forecasts for 2022 to 3.1% in 2022, down from 3.8% previously. The downgrade is driven almost entirely by weaker private consumption; we now expect growth to be a full percentage point below the current Bloomberg consensus in both 2022 and 2023, at 2.2% and 1.4% respectively. While services should continue recovering from the end of pandemic restrictions, discretionary goods consumption is likely to see a bigger hit than previously thought.

As if this were not enough for consumers to contend with, the Fed has continued its aggressively hawkish volte-face, and is signalling an even steeper rise in interest rates. This is already pushing longer term interest rates significantly higher, with mortgage rates jumping 1.5pp over the past month to 4.5% at the end of March – the highest since early 2019. With markets reacting in a sanguine manner to hints of larger 50bp rate hikes, we think this gives the Fed the green light to raise rates by 50bp at the May and June meetings. Thereafter, we expect more gradual 25bp rate rises at each meeting, until the target range for the fed funds rate reaches 2.5-2.75% – a little above its neutral estimate of 2.4% – by early 2023. From there, we expect the Fed to pause as a base case, although this depends naturally on inflation and on how much the economy has slowed by that point.

Our base case is that although inflation will still be above target, that it will have significantly fallen by then. We also think consumption growth will have cooled. Provided the Fed is on track to bring inflation back to target, we think it will seek to steer the economy to a soft landing rather than accentuate any slowdown more than is necessary. Should the Fed continue hiking, however, excessively tight policy could ultimately trigger a more lasting downturn.