Summary
Highlights
Pepsi's CEO, Ramon Laguarda, stated that the consumer is 'worse than what we had anticipated,' mainly due to gas prices. The company's North American beverage division saw a 4% drop in sales volume, and their food business was flat. This indicates demand destruction, as consumers are pulling back and buying less, rather than experiencing an inflationary boom. This contradicts the mainstream narrative of a resilient consumer and points to a consumer economy in a far worse state than acknowledged by institutions like the Federal Reserve.
The mainstream narrative has suggested that Americans are resilient and continue to spend despite higher prices. However, data indicates that spending has softened, and job growth is not robust when considering labor force dropouts. Pepsi's volume numbers are more critical than revenue, as they reveal underlying consumer behavior. The decline in Pepsi's sales volume, coinciding with surging gas prices, highlights a fragile consumer base. If consumers were financially secure, higher gas prices would be manageable, but instead, they're forced to make trade-offs on basic household items, signaling a broader issue beyond discretionary spending.
Federal Reserve data on consumer credit, particularly revolving credit, shows a sharp drop in balances in May, the most in almost two years. While paying down credit card debt can be positive, in this context, it suggests households are reaching their financial limits. Consumers used credit cards to absorb initial shocks like rising gas prices, but then pulled back significantly. This demonstrates demand destruction, where consumers initially try to absorb costs with savings and credit, but eventually cut back on spending, reducing discretionary purchases, and delaying big-ticket items. Businesses are encountering resistance to price increases, leading to a focus on volume rather than higher prices.
The housing market further confirms the struggle of the American consumer. Sales of previously owned homes unexpectedly fell in June, with economists often blaming mortgage rates. However, the underlying issue is weak household demand. People buy homes when they have stable jobs, rising incomes, confidence in the future, and adequate savings. The fragile labor market, reduced credit, and high gas prices are eroding these conditions, making a strong housing market impossible. Home prices are flattening or slipping despite tight supply, indicating that demand is even weaker than advertised, reflecting a lack of buyers rather than just high rates.
Retailers are aware of the consumer's weakened state and are adapting their strategies. They are focusing on 'miniaturization,' offering smaller products, lower-ticket items, and cheaper treats to appeal to shoppers who want to buy something without committing much money. This is a significant macro signal; when consumers are strong, retailers upsell, but when they are weak, retailers lower the psychological barrier to purchasing. This behavior, alongside Pepsi's volume decline, indicates that consumers are buying less, choosing more carefully, and making tradeoffs, showing a weak consumer economy before it becomes obvious in broader economic numbers.
The Federal Reserve and mainstream economists are misinterpreting inflation, focusing on psychology or cost-push factors like oil prices, while overlooking the consumer's true state. The consumer is not resilient, and the economy is not healthy. The Fed fears that higher energy prices will lead to businesses passing costs to consumers and workers demanding higher wages. However, for 'second-round inflation' to occur, there needs to be robust demand, which the current economy lacks. Businesses cannot pass on higher costs if consumers refuse to pay, resulting in lower sales volumes, as shown by Pepsi's report and overall market data, which signals disinflation rather than inflation.
The US economy, and the global economy, was already in poor shape before the energy shock. The narrative of resilience from figures like Christine Lagarde and Jay Powell was never true. Higher gas prices acted as a 'tax' on already struggling households with thinning savings, maxed-out credit, and a weakening labor market. Pepsi's beverage volume decline, decreased consumer credit, falling home sales and prices, and retailers' adaptation to smaller transactions all point to demand destruction. The consumer's response to higher gas prices is to cut back, not to absorb costs willingly. This collectively indicates a weak consumer economy that is getting even weaker, directly contradicting the Federal Reserve's inflation-centric view.