Consumer Spending: The Fragile Jenga Tower and Its Market Implications

The headline data tells a story of choppy, uneven growth. On one hand, the latest retail sales report shows a sharp December surge, with total retail sales up 1.26% month-over-month and holiday season spending hitting 4.1% year-over-year. Yet this festive pop masks a more complex reality of trade-downs and prioritization, where consumers are making fewer, but more deliberate, purchases. On the other hand, the broader economic picture reveals a year of sluggish expansion. Real personal consumption expenditures (PCE) in June 2025 were 0.07 percent below their December 2024 level, indicating a full year of minimal growth after a strong start.

This divergence points to a fragile, dependent structure. The spending resilience is increasingly concentrated, supported by a specific segment of the population. While consumer sentiment dropped considerably in the fourth quarter, with a 16-point swing in net optimism, overall spending has not followed suit. This split is puzzling, but evidence suggests a key driver: affluent consumers are holding the line. A Boston Fed economist analyzing credit card data found that more than half of the spending growth is coming from the highest-income consumers, whose growth rate is particularly significant. In other words, the economy is being propped up by a narrow base of spending, while the broader consumer base feels economic unease and is trading down.

The setup is structurally vulnerable. The recent retail sales strength may simply reflect a timing shift, with durable goods spending having surged earlier in the year before pulling back. The current slowdown in PCE, coupled with a decline in the diffusion index that measures the breadth of spending, suggests this is not a broad-based retreat but a more targeted pullback. The consumer economy, therefore, is a fragile Jenga tower-held together by the spending of a few, while the rest of the structure shows signs of instability.

The Drivers of Fragmentation: Policy, Prices, and Payback

The bifurcated consumer behavior we observe is not random. It is the direct outcome of specific, quantifiable pressures that are reshaping household budgets and decision-making. Three structural forces are at work: a significant new tax on imported goods, a deeply cautious savings posture, and a cyclical pull-forward in durable goods spending that has now run its course.

The most direct and quantifiable burden is the tariff wall. Consumers are facing an overall average effective tariff rate of 16.8%, the highest since 1935. In the short run, this policy has already translated into higher prices, with the price level rising by 1.2%. For the average household, that represents a tangible loss of $1,700 annually. This is a regressive tax that hits the average family hard, directly reducing disposable income and amplifying the pressure to trade down. The burden falls most heavily on apparel and products with high metal content, sectors where consumers are already showing sensitivity.

Against this backdrop of rising costs, the broader consumer is adopting a posture of extreme caution. The personal saving rate stood at 4.0% in September, a level that reflects a deliberate effort to build a buffer. While this rate has been relatively stable, its persistence signals a deep-seated wariness. With little room to maneuver, households are prioritizing essential spending and deferring discretionary purchases, a dynamic that fuels the observed trade-downs and concentrates growth among those with the deepest pockets.

Finally, a significant portion of the 2025 slowdown appears to be cyclical, not structural. Evidence points to a classic "payback effect" from a durable goods spending surge earlier in 2024. Real spending on durable goods surged at an annualized rate of 13.7% in the six months leading up to December 2024 before falling 5.8% annualized in the following six months. This pattern suggests that a wave of pent-up demand was pulled forward into 2024, leaving a void in 2025. The diffusion index for spending, which measures the breadth of growth, supports this view-while overall spending is down, the majority of expenditure categories are still seeing growth, indicating the slowdown is concentrated in a few areas rather than a broad retreat in demand.

Together, these forces create the fragmented landscape. The tariff-driven price shock and cautious savings rate are the structural headwinds compressing the budget of the average household. The payback effect from earlier durable goods spending provides a specific, temporary reason for the recent slowdown in that category. The result is a consumer economy where spending is increasingly dependent on the affluent, who have the financial flexibility to absorb these pressures and maintain their purchases, while the broader base is forced to prioritize and trade down. This is the fragile foundation of the Jenga tower.

Sector Implications and Financial Impact

The consumer fragmentation we've identified is now translating into starkly different financial outcomes across sectors. The market is pricing in this divergence, with ratings reflecting where the stress is most acute. The Consumer Discretionary sector is rated Underperform, a direct call on the pockets of stress we see, particularly among lower-income households. This rating acknowledges the cyclical pullback in durable goods and the broader caution that is compressing discretionary budgets. In contrast, sectors like Communication Services and Health Care are rated Outperform. Their resilience likely stems from more defensive demand patterns and, in the case of Communication Services, potential benefits from technology adoption that can insulate them from immediate consumer spending volatility.

The tariff policy is a key driver of this sector divergence, and its impact is most visible in the durable goods category. Evidence shows that prices for durable goods-such as vehicles, electronics and furniture-have increased noticeably, with these price movements aligning with the timing of tariff hikes earlier in 2025. This is a direct transmission of the structural cost pressure we discussed. For the consumer, this means a higher barrier to entry for big-ticket purchases, directly contributing to the payback effect we observed in the earlier spending surge. The financial impact here is twofold: it pressures margins for retailers and manufacturers, and it directly reduces the purchasing power of the average household for these specific items.

Adding to the pressure on the consumer-facing economy, the latest Beige Book confirms a stalled labor market and increased anxiety among retailers. The report notes that anemic economic growth reflects anxiety among working families who are paying higher prices for essentials. This creates a feedback loop: stagnant wages and hiring constraints limit income growth, while tariff-driven price increases squeeze budgets. Retailers, already facing this pressure, are now signaling they may implement further price increases in the first half of 2026 to preserve margins, a move that could further dampen demand.

The bottom line is that the financial impact is concentrated. The Consumer Discretionary sector's Underperform rating captures the risk that the narrow base of affluent spending cannot indefinitely prop up the entire sector. The durable goods price hikes, a direct tariff pass-through, are a visible headwind that aligns with the cyclical slowdown. And the Beige Book's report of a labor market stalling and retailer anxiety signals that the pressure is building on the very front lines of the consumer economy. This is the fragile Jenga tower in action: the structural forces of tariffs and cautious savings are now manifesting as sector-specific financial stress, with the most vulnerable parts of the economy showing the first cracks.

Forward Scenarios and Key Catalysts

The fragile, bifurcated consumer economy we've outlined faces a clear fork in the road. The path forward hinges on two primary catalysts that will either validate the current thesis of structural vulnerability or provide a meaningful relief valve. The baseline forecast suggests a gradual, but persistent, slowdown in the engine of growth.

Our baseline scenario sees real consumer spending decelerating to 1.6% in 2026, down from 2.6% in 2025. This modest slowdown is driven by a combination of weaker population growth and the potential for a sudden pullback in AI investment in the downside case. For the consumer, this means a continuation of the choppy, uneven expansion we've seen. The spending resilience of the affluent will likely persist, but the broader base, already under pressure from tariffs and cautious savings, will have even less room to maneuver. The market implication is a continuation of the sector divergence we've observed, with Consumer Discretionary facing ongoing headwinds.

The primary catalyst to watch is the evolution of the labor market and wage growth. The Beige Book confirms a stalled labor market, with anemic hiring and increased anxiety among retailers. A sustained rise in unemployment would directly threaten the spending resilience of the broader consumer. This is the structural fragility in action: the consumer economy is held together by a narrow base of affluent spending, but that base is not infinite. If the labor market deteriorates further, the trade-downs we've seen could accelerate into a broader retreat, invalidating the current thesis that the affluent can indefinitely prop up the entire sector. The market would need to reassess the durability of the Consumer Discretionary sector's earnings, likely leading to further downgrades.

The second, more specific catalyst is the resolution of the Supreme Court case on the IEEPA tariffs. The potential outcome here is a direct, quantifiable relief valve for consumer budgets. The Budget Lab estimates that if these tariffs are invalidated, the price level impact would be halved, falling from a 1.2% rise to 0.6%. For the average household, this would mean a savings of $1,700 annually, effectively reversing half the tariff-driven tax. This scenario would provide a tangible boost to disposable income, particularly for lower-income households who bear a disproportionate burden. It could also mitigate the 0.6 percentage point rise in the unemployment rate projected for 2026, offering a more stable foundation for spending.

Viewed through the lens of the Jenga tower, these catalysts represent the forces that could either keep the structure standing or cause it to collapse. The baseline forecast of a slow creep toward 1.6% growth assumes the current pressures continue, with the tower leaning but not falling. The labor market deterioration is the tremor that could trigger a cascade. Conversely, a Supreme Court ruling that invalidates the IEEPA tariffs is the unexpected removal of a key block from the base, potentially stabilizing the entire structure. For investors, the key is to monitor these specific events-not just headline spending numbers-as they will determine whether the fragile, bifurcated recovery is a temporary dip or the start of a more profound shift.