The slowdown in US consumption mainly stems from services and pressure on real income, with a moderate recovery expected in the second half

Overview

This report discusses why US consumption growth has slowed year to date in 2026. Morgan Stanley believes the core reason is that high inflation has eroded purchasing power, compounded by tariff pass-through, rising oil prices, and residual seasonality in first-quarter inflation data, which weakened real income and restrained real consumption. The slowdown is most evident in services consumption, while durable goods consumption has remained strong due to tax refunds and some pent-up demand. The report expects consumption to re-accelerate moderately as inflation slows in the second half and real income turns positive, though full-year growth will still remain below 2025 levels.

Core views

The report's core judgments are: first, the slowdown in consumption is not a broad collapse in demand, but rather a downshift in growth after real purchasing power was squeezed; second, the sudden weakness in services consumption may have been affected by data revisions and seasonal factors, and could be revised upward once August QSS data are incorporated; third, tax refunds may have been spent faster than expected, explaining the strength in durable goods and big-ticket items; fourth, consumption growth remains K-shaped, with high-income-led categories performing better, while middle- and lower-income consumers may not gradually recover until 2027 after inflation eases and wages improve.

Analysis framework

The report combines BEA personal income and consumption data, the 1Q GDP revision, the AlphaWise Consumer Pulse survey, auto ABS delinquency performance, BLS/CEX consumption structure, and an oil price model to break down the factors behind the consumption slowdown across price, income, category mix, tax refunds, and income segmentation, and to form a consumption path forecast for 2H 2026 through 2027.

Methodology notes

• Macro Consumption ForecastingReal PCE Decomposition Framework

  Breaks real consumption into goods, durables, nondurables, and services, and compares current growth with the previous year's growth.

  This framework is used to identify that the consumption slowdown comes from services rather than goods, and to explain why durable goods growth is moving differently from the overall slowdown.

• Income and Price TransmissionReal Income-Inflation Pressure Framework

  High inflation, tariffs, and oil prices affect consumption by depressing real income.

  The report argues that residual seasonality in the first quarter and the energy price shock mechanically depressed real consumption, estimating a first-quarter drag of about 60-80 bps.

• Consumer Behavior SurveyAlphaWise Consumer Pulse Tax Refund Spending Intentions

  Uses consumers' intentions for saving, debt repayment, and spending tax refunds to explain short-term goods consumption.

  The survey shows that intentions to save and repay debt declined slightly year over year, while intentions in some consumption categories rose, consistent with stronger spending on home improvement and big-ticket goods.

• Credit ValidationRelationship Between Auto ABS Delinquency Rates and Tax Refunds

  Historically, tax refunds usually improve auto ABS delinquency rates; if the improvement is weaker than the model expects, it may indicate that more refunds were used for consumption rather than debt repayment.

  This year, improvements in both prime and subprime auto ABS delinquencies were weaker than the historical relationship, supporting the view that tax refunds flowed more quickly into consumption.

• Consumption SegmentationK-Shaped Consumer and Income Quintile Analysis

  Uses spending shares by income group across consumption categories to determine which groups are driving consumption growth.

  The top 20% income group accounts for about 40% of total consumption and 55% of durable goods consumption, so strong categories such as autos, furniture, and recreational vehicles are more likely to be led by high-income consumers.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US real personal consumption expenditures (PCE)

  Core macro variable

  Strengths

  Easing inflation and a return to positive real income in the second half are likely to drive a moderate re-acceleration.

  Weaknesses

  First-half growth was only 1.2% annualized, still clearly below 2025.

  Comparison

  Full-year 2026 is expected at 1.7%, below 2.1% in 2025.

  Risks

  If inflation proves stickier or monetary policy is tighter, the consumption recovery may be hindered.

• Services consumption

  Main source of slowdown and a potential recovery area in the second half

  Strengths

  Services employment has recently rebounded, and there is potential for upward revision once QSS data are incorporated.

  Weaknesses

  Many services categories slowed broadly in the first quarter, including travel, dining, healthcare, financial, and professional services.

  Comparison

  As of May, services consumption growth was 1.1%, significantly below 2.4% in 2025.

  Risks

  If services data are revised downward, it would indicate that the underlying trend is weaker than the report assumes.

• Durable goods and big-ticket goods consumption

  A relative area of strength in this year's consumption mix

  Strengths

  Autos, furniture, appliances, home improvement, and similar categories were supported by tax refunds and pent-up demand.

  Weaknesses

  Growth may depend on one-off refunds, and oil price shocks and high interest rates may weigh on goods consumption with a lag.

  Comparison

  As of May, durable goods grew at a 2.3% annualized rate, above 0.1% on a 4Q/4Q basis in 2025.

  Risks

  Weaker refund support, lagged oil price effects, and elevated borrowing costs may lead to a pullback.

• Middle- and lower-income consumers

  Potential recovery group but still under pressure in the short term

  Strengths

  If inflation falls, gasoline prices decline, and low-income wage growth improves, consumption may recover in 2027.

  Weaknesses

  Real income has been under pressure for several consecutive quarters, and cuts to Medicaid and SNAP benefits are also headwinds for lower-income groups.

  Comparison

  This year's accelerating categories are still more dominated by high-income consumers, and recovery for middle- and lower-income groups may lag.

  Risks

  Persistent K-shaped consumption, an affordability crisis, and rising borrowing costs would limit the recovery.

• Energy prices and Oil & Gas-related macro shocks

  Important exogenous variable for consumer purchasing power and goods consumption

  Strengths

  If oil prices come in below expectations or gasoline prices continue to fall, pressure on real income would ease.

  Weaknesses

  Earlier oil price shocks have already depressed purchasing power and may weigh on goods consumption in the third quarter with a lag.

  Comparison

  The report cites the commodities team's forecast for dated Brent to remain at $70-75 through end-2027.

  Risks

  If the extent of energy supply reconfiguration is smaller than expected or oil prices rise again, the risk of slower consumption increases.

Key data

• Real consumption growth in the first half1.2% annualizedBelow 2.1% in 2025, indicating a clear slowdown.
• 1Q and 2Q consumption tracking0.5% in 1Q, about 1.9% SAAR in 2QThe first quarter was very weak, while the second quarter saw some rebound.
• Goods versus services consumptionAs of May, real goods consumption growth was 1.7%, while services consumption growth was 1.1%These were 1.4% and 2.4% in 2025, respectively, showing that services are the main source of the slowdown.
• Durable goods consumptionAnnualized growth of 2.3% as of MayOnly 0.1% on a 4Q/4Q basis in 2025, with autos, furniture, and appliances among the main contributors.
• Residual seasonality dragAbout 60-80 bpsThe report estimates that residual seasonality in first-quarter high inflation mechanically dragged on real consumption; excluding it, first-half growth would be about 1.6%.
• Tax refund scaleUp 19% year over year, about $57bnThe scale was broadly in line with expectations, but the share actually used for immediate consumption may have been higher than originally assumed.
• Immediate refund spending assumptionOriginal assumption 35%, possibly closer to 50%If about 50% of refunds were spent within three months, and mainly on goods, that could explain why second-quarter goods consumption was stronger than forecast.
• Improvement in auto ABS delinquenciesPrime auto ABS down 15% versus expected 19%; subprime auto ABS down 17% versus expected 21%Delinquency improvement was weaker than the historical relationship, suggesting that a lower share of refunds may have been used for debt repayment.
• Consumption forecast for the second halfAbout 2.0% in 3Q and 4QAbout 0.5 percentage points higher than in the first half, and expected to be driven by services consumption.
• Full-year consumption forecastAbout 1.7% 4Q/4Q in 2026Below 2.1% in 2025, but improved relative to the first half.
• PCE inflation forecastHeadline PCE at 3.3%, core PCE at 3.0% (4Q/4Q)Morgan Stanley is more optimistic than the Fed on disinflation and then expects inflation to move closer to the 2.0% target.
• Real income forecast2.2% annualized growth in 2H 2026The recovery in real income is the key support for the moderate re-acceleration in consumption.
• Top 20% income share of consumptionAbout 40% of total consumption, about 55% of durables, about 30% of nondurablesExplains why the durable goods and big-ticket categories that accelerated this year are more dominated by higher-income consumers.
• Brent oil price assumption$70-75 through end-2027Based on Morgan Stanley commodities analysts' forecast; the size of the oil price shock is a risk variable for consumption.

Impact & implications

The report's asset implications are more macro and sector-allocation oriented: if inflation falls as expected and the Fed remains on hold this year, improving real income will support stabilization in US consumption in the second half, and in 2027 this could broaden to more income groups and consumption categories. In the short term, services consumption may recover, while durable goods consumption may face headwinds from tax-refund pull-forward effects and lagged oil price drag. For consumer stocks, consumer credit, industries sensitive to energy prices, and rate-sensitive assets, the key variables are inflation, oil prices, employment, and financial conditions.

Risks

• Inflation remains elevated and real income does not recover as expected.
• Tighter monetary policy is needed to suppress inflation, causing further tightening in financial conditions and borrowing costs.
• If services consumption data are revised downward in subsequent revisions, it would indicate that the underlying consumption trend is weaker than currently judged.
• The drag from oil price shocks on goods consumption may be greater than expected.
• K-shaped consumption and affordability pressures persist, and middle- and lower-income consumers recover more slowly than expected.
• Cuts to Medicaid and SNAP benefits may offset part of the improvement in real income for lower-income groups.

What to watch

• Whether services consumption is revised upward after QSS data are incorporated in August.
• Whether headline and core PCE inflation decline in the second half as projected in the report.
• Whether real disposable income and low-income wage growth continue to improve.
• Gasoline prices, Brent oil prices, and the lagged effects of oil price shocks on goods consumption.
• Whether post-tax-refund payback suppresses durable goods and goods consumption in the second half.
• Whether employment growth remains strong, especially in the services sector.
• Whether the Fed remains on hold and whether financial conditions ease.
• Whether consumer credit indicators such as auto ABS and credit cards show rising debt-servicing pressure.