Wells Fargo Warns of Hidden Recession Signal as Spending on Services Declines 0.3%

Wells Fargo has issued a warning about the economic data, suggesting that there is a hidden recession signal. The bank's economists, Tim Quinlan and Shannon Grein, have pointed out that recent economic data has been revised downward, indicating a decline in discretionary spending on services. This trend has historically been associated with recessions or periods immediately following them.

The economists dismissed the notion that tariffs have had a benign impact on the economy, highlighting that initial estimates of GDP growth and consumer spending were significantly higher than the revised figures. For instance, the initial estimate of inflation-adjusted Q1 consumer spending was 1.8%, but this was later revised down to 0.5%. Similarly, services spending growth was revised from 2.4% to 0.6%.

Wells Fargo's analysis shows that while discretionary spending on goods has remained stable, spending on services has decreased by 0.3% year-over-year through May. This decline is significant because, historically, this measure has only decreased during or immediately after recessions. The bank noted that spending on food services and recreational services has barely increased, while transportation spending has decreased by 1.1%, with air travel seeing the steepest drop at 4.7%.

The economists also pointed out that the increases in spending on goods appear weaker than they seem, as categories like cars and appliances saw temporary surges due to consumers rushing to buy items before tariffs hiked prices. Additionally, the muted inflation data may be misleading, as businesses have stockpiled extra inventory ahead of tariffs and have been able to draw on those supplies to avoid passing on tariff costs to consumers.

Wells Fargo's warning comes amid a debate over the economic outlook and whether the Federal Reserve should resume rate cuts. Some policymakers argue for a rate cut this month due to weak job readings, while others prefer to wait, citing the economy's resilience and the lack of tariff-induced inflation in the data. The retail sales report released on Friday showed a bigger-than-expected jump last month, but this dataset mostly covers spending on goods.

The latest consumer price index came in below expectations, but it still showed signs that tariffs were putting upward pressure on inflation. Wells Fargo's economists concluded that consumer spending is not as sturdy as previously thought and that consumers have shifted their behavior in response to tariffs. They suggested that a stable labor market could offset tariff-induced inflation and prevent a more severe recessionary impulse.