Americans are shifting their spending and keeping the economy afloat.

• Americans are shifting spending from goods to services as the economy normalizes.
• The shift keeps the recovery alive as consumer spending accounts for two-thirds of GDP.
• But the transition is risky, as each shock can cut overall spending and threaten a downturn.

LoadingSomething is loading.

After more than a year of above-average spending, Americans are changing it. That’s not necessarily a bad thing.

The spending spree that pulled the economy out of the coronavirus recession is winding down. Spending at retailers and restaurants was flat in July, slowing from a 0.8% gain in the previous month, the Census Bureau said on Wednesday. That was just below the median forecast of a 0.1% gain by economists polled by Bloomberg and marked the smallest monthly gain since sales fell in December.

Consumer spending accounts for about two-thirds of all economic activity, making it a crucial factor in the country’s recovery. Wednesday’s print edition signals that Americans are beginning to pull back, and comments from the country’s biggest retail chains suggest the slowdown is even worse. Target shares tumbled Wednesday after the company reported an 89% fall in second-quarter earnings, attributing the plunge to price cuts needed to shed unwanted inventory.

Walmart fared better when it reported quarterly earnings on Tuesday, but similar rebates and inventory clearances are expected to cut full-year earnings by 9% to 11%. Executives said on Tuesday that the chain had canceled “billions of dollars in orders” to better match supply with slacking demand from shoppers.

Walmart’s second-quarter revenue was boosted by an unusual cohort: high-earning Americans. Households with incomes of $100,000 or more visited the chain more frequently in the second quarter to avoid inflation, Walmart CEO Doug McMillon told CNBC on Tuesday.

“People are really price oriented now, regardless of income level,” he added.

On the surface, the pullback looks like a worrying trend in the still recovering economy. However, other indicators suggest that Americans are not cutting spending entirely, instead shifting spending to sectors that were largely unpopular just a few months ago.

From the goods gold mine to the revival of the service industry

The first lockdowns of 2020 and economic reopening the following year saw Americans spend heavily on goods. This increase is finally leveling out as Americans shift spending to services. Leisure and dining activities have boomed in recent months as Americans take advantage of the summer travel season.

Inflation was also most intense in the goods manufacturing sectors. As households avoid rising prices and return to their pre-crisis spending habits, services are likely to have their time in the sun.

“Consumer spending is much broader than retail sales alone,” said James Knightley, chief international economist at ING. “[The spending shift] has a long way to go as retail sales will lag broader spending trends in the coming quarters.”

The pivot is not without significant risk. Inflation cooled over the year to 8.5% through July, but that’s still near a four-decade high. The road to sustainable inflation levels may be bumpy as supply chain issues and Russia’s invasion of Ukraine still cloud economic prospects. Should inflation continue to rise in the service sectors, Americans could cut spending overall and take fuel away from the economic engine.

The shift in spending from goods to services is also at an early stage and has a long way to go before trends return to pre-crisis norms. If some sort of shock stalls the recovery — whether it’s a rise in unemployment or a return to last year’s supply shortages — households could quickly rein in spending on services and send the economy into a downturn, said Brett Ryan, a senior US economist at the Deutsche Bank Bank, insiders said.

“Merchandise spending is falling back to the pre-COVID trend, but there’s still a long way to go,” Ryan said. “However, it is this shift from spending on goods to services that can still trigger a recession.”

So far, the transition has been going smoothly. Second quarter personal consumption spending data reflected stronger spending on services, only partially offset by weakness in the goods sector.

In other words, Americans continued to spend overall, just in different areas of the economy. And the latest retail sales pressure suggests the transition continued through July.