The Federal Reserve has nearly achieved its two percent inflation target. April 2025’s Personal Consumption Expenditures (PCE) index came in at 2.1 percent year-over-year, with Core PCE sitting slightly higher at 2.5 percent. (The core metric excludes volatile components, such as food and energy prices.) Food prices decreased by 0.3 percent, while energy prices rose by 0.5 percent. Housing, a particularly sticky component of inflation, climbed another 0.4 percent, underscoring ongoing cost pressures.
A common misconception is that the Fed targets core inflation; however, its focus is on the headline PCE number, which now rests just above that critical two percent threshold. Yet, April’s economic data delivered seemingly contradictory signals. Despite a substantial rise in personal incomes for the month (up 0.8 percent), the pace of consumer spending sharply decelerated, increasing only 0.2 percent after a robust 0.7 percent rise in March. Simultaneously, personal savings surged, reaching 4.9 percent. This unusual uptick could be misread as a consumer retreat. However, the consumer pullback may be more strategic than structural.
Recent insights from the Conference Board revealed that many households pulled forward planned purchases to preempt President Trump’s so-called reciprocal tariffs, announced on April 2, 2025, which he termed “Liberation Day.” Specifically, 26 percent of households earning over $125,000 accelerated their purchases ahead of these tariffs, and 13 percent of households earning under $50,000 did the same. This behavior seems tactical rather than a signal of permanently diminished spending activity. However, it is not all about getting ahead of the tariff curve.
According to information from SecureSave, an administrator of employer-sponsored emergency savings accounts, workers have real economic concerns. SecureSave reported that customers are contributing 20 percent more per paycheck compared to the same period in the previous year.
I expect consumer spending to be weak, but not negative, over the next 12 months. And it is not just lower-income Americans who are feeling the effects of higher prices. According to Deloitte, households earning more than $200,000 also report being more price sensitive when it comes to non-essential expenses.
Households’ inflation concerns seem to be primarily driven by tariff dynamics. Before Liberation Day, the effective tariff rate hovered around 2.25 percent. Following the announcement, tariffs spiked dramatically to an effective rate of between 14 percent and 15 percent. (The effective rate is calculated by dividing the revenue raised by the dollar amount of goods tariffed.)
Typically, each percentage point rise in tariffs contributes roughly 10 basis points (0.1 percent) to the PCE index. Sustained tariffs at current rates could elevate inflation from its current 2.1 percent to approximately 3.4 percent within a year. Such inflationary pressures would likely keep the Federal Reserve cautious, maintaining higher interest rates, a clear headwind for businesses, equity markets, and consumer spending. But it is not just about inflation.
Another reason consumer spending is likely to stagnate over the next 12 months is that, after a period of “revenge spending” following the COVID-19 pandemic, consumers are becoming increasingly uncertain about the economy and their job prospects. Some of that uncertainty stems from the lack of clarity on what taxes will look like in 2026.
The “One, Big, Beautiful Bill,” President Trump’s ambitious tax legislation currently awaiting Senate action, remains at the forefront of investor discussions. Proponents insist the bill will sufficiently boost economic growth to offset its costs. At the same time, opponents dismiss these projections as overly optimistic. Politicians on both sides of the aisle frequently tout optimistic forecasts, but real-world outcomes seldom align perfectly with projections. My analysis suggests a tempered optimism. Although the bill may stimulate growth initially, history suggests its actual impact will fall short of covering its substantial expense.
This tax legislation would significantly amplify the U.S. budget deficit, necessitating a surge in Treasury issuance. Currently, the debt-to-GDP ratio stands at around 97 percent, but under this scenario, it is projected to swell to nearly 130 percent within the decade. As a comparison, the budget deficit was approximately 40 percent before the Great Financial Crisis.
According to Congressional Budget Office analysis, every percentage point increase in debt-to-GDP pushes the yield on the 10-year Treasury bond higher by roughly two basis points (0.02 percent). Therefore, a 30-point increase implies a 60-basis-point (0.60 percent) rise in yields. Practically speaking, the current yield of 4.5 percent would rise to about 5.1 percent, further burdening government financing costs and economic activity.
I do not suspect that many investors are directly incorporating long-term interest rate data into their decision-making process. However, the Federal Reserve is, and the associated lower economic growth resulting from higher interest rates will prompt them to leave interest rates higher than they might have been otherwise. That is not favorable for household consumption, but it is not necessarily a spending cliff, either.
The weak household consumption I expect over the next year will not be the trigger for a recession; however, it may leave the economy so fragile that it remains vulnerable to a shock.
Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
