The Concurrent Decline of U.S. Consumption Indicators and Signals of Economic Slowdown in North America: Risks in the Midterm Election Phase and Responses from Korean Enterprises

Executive Summary

In July, U.S. retail sales decreased by 0.6%, and the University of Michigan's Consumer Confidence Index fell to 51.0, confirming that the effects of tax refunds have been exhausted and that the employment shock in July is shaking the very foundation of consumption. Price indicators show a trend of deceleration, increasing the likelihood of a Federal Reserve interest rate cut at the September FOMC meeting. However, emerging market currencies, including the peso, are experiencing significant volatility, fluctuating widely in response to geopolitical risks and U.S. macroeconomic data releases. The East Asia Institute (EAI) presents a scenario where consumption contraction continues moderately, with a 50% probability, and considers both early hedge reduction and comprehensive business downsizing as hasty responses. Korean enterprises should refrain from new large-scale currency exposure until the September FOMC, maintain their current hedge ratios, and gradually readjust their forecasts for U.S. consumer goods based on a downward scenario. A differentiated approach is required, with a larger adjustment in discretionary consumer goods such as durable goods and clothing compared to essential consumer goods.

I. Issue Situation Analysis

The Decline in U.S. Retail Sales and Consumer Sentiment, Signals of Economic Slowdown in North America: Issue Situation Analysis

1. Background and Progress

On August 14, the U.S. Census Bureau released the retail sales figures for July, which showed a decrease of 0.6% compared to the previous month. The June figure was revised to a 0.2% increase without any adjustments. The economist forecasts compiled by Reuters indicated a slight increase, but the actual results deviated significantly from this.

Looking at the background, the consumption boom until June was largely dependent on the effects of large-scale tax refunds. As these effects have been exhausted, the July figures have sharply declined. This was compounded by the consumer sentiment indicators. The University of Michigan's Consumer Confidence Index fell from 55.2 in July to 51.0 in early August, also falling short of the market consensus of 54.5. The Michigan survey team cited concerns that tensions in the Middle East could lead to rising living costs as a contributing factor to this decline.

This trend is linked to the previously announced shock in the July employment figures. Non-farm employment decreased by 23,000, and the combined figures for May and June were revised down by 103,000. EAI has evaluated this as having "cracked the narrative of economic recovery under the Trump administration." The decline in retail sales and consumer sentiment is interpreted as a follow-up indicator reaffirming this crack.

2. Current Situation

According to an article from the Mexican financial media El Financiero on August 14, the decline in the New York stock market immediately after its opening was directly linked to the poor retail sales and consumer sentiment figures. The Nasdaq fell by 0.44%, the Dow Jones by 0.19%, and the S&P 500 by 0.15% at the start. The same media outlet quoted market participants stating that "a month of poor consumption data does not mean economic collapse," but that "when combined with poor employment data, it reaches a level that cannot be ignored."

Similar views were expressed by the Argentine media Ambito Financiero. In a report on August 14, it pointed out that despite the S&P 500 reaching an all-time high the previous day, the decline in retail sales and the drop in consumer confidence eroded that gain. This media outlet presented the decline in retail sales as a headline figure of 0.6% and a core figure of 0.2%.

In the foreign exchange market, contrasting trends are emerging simultaneously. As of August 10, the peso weakened to 17.14 pesos per dollar due to risk aversion stemming from geopolitical concerns. However, on August 12-13, the U.S. wholesale price index showed a greater-than-expected slowdown, reversing this trend. The decline in energy prices was identified as a primary cause. El Financiero described this as a "signal that eases pressure on the Fed." The peso approached the 16 peso mark against the dollar. Reports also emerged that the Philippine peso showed signs of rebounding during the same period due to the weak U.S. employment figures. A pattern has been confirmed where emerging market currencies generally strengthen in response to poor U.S. macroeconomic indicators.

From an inflation perspective, conflicting signals exist. The consumer price index for July rose by 3.4% year-on-year, slightly down from 3.5% in June. Daily Sabah analyzed that the impact of rising oil prices due to the Iran war on broad inflation was limited. Conversely, the University of Michigan's consumer sentiment survey specifically identified concerns about rising living costs stemming from the Middle East as a cause of psychological contraction. This indicates a discrepancy between actual price statistics and consumer perceptions.

3. Key Actors and Positions

Federal Reserveis the most direct stakeholder in this combination of indicators. The slowdown in wholesale prices and poor employment figures have increased the likelihood of an interest rate cut at the September FOMC, according to the prevailing interpretation in local markets. A market strategist quoted by El Financiero stated, "The combination of poor employment figures and the absence of inflation re-acceleration gives the Fed more time to wait." The Fed now faces the burden of balancing policy between price stability and employment slowdown.

Trump Administrationis likely to perceive these indicators as burdensome materials in terms of managing the economic narrative. EAI's previous analysis characterized the July employment shock as a "political blow ahead of the midterm elections." The decline in retail sales and consumer sentiment serves as a reaffirmation of this blow from the consumption side. In particular, the fact that the cause of the drop in consumer sentiment is the situation in the Middle East suggests that external policy risks, in addition to tariff policy, are impacting the domestic economic narrative.

Mexican financial market participantsunderstand peso exchange rate fluctuations as a function of U.S. macroeconomic indicators and carry trade capital flows. An analysis quoted by El Financiero projected that "if the global risk appetite environment is maintained and carry trade capital continues, the peso may solidify below the 16 peso mark." In other words, the strength of the peso is interpreted as a phenomenon linked to changes in expectations regarding U.S. monetary policy rather than Mexico's internal fundamentals.

U.S. Consumersare the fundamental variable of this indicator. The Census Bureau's statistics reflect a one-time factor of the exhaustion of tax refund effects, but the University of Michigan survey shows that concerns about future living costs due to Middle Eastern risks are fundamentally shaking consumer sentiment. An optimistic view that the wealth effect from rising asset prices will continue to support consumption is also included in the Census Bureau data. The differentiation in consumption capacity based on consumer strata and asset ownership may become a key variable for future indicator volatility.

4. Key Issues

The first issue is whether the decline in July retail sales is a one-time adjustment or the beginning of a trend of deceleration. There are interpretations that coexist: one explaining it as a base effect due to the exhaustion of tax refunds, and another as a structural signal compounded by poor employment and weakened consumer sentiment.

The second issue is the discrepancy between actual price indicators and consumer perceptions of inflation. While the CPI growth rate shows a trend of deceleration, consumer sentiment has declined due to concerns about rising costs stemming from the Middle East. Whether this discrepancy will lead to actual consumption contraction or remain as psychological noise will be verified in the next indicator release.

The third issue is the direction of the Fed's policy decision in September. Although the slowdown in wholesale prices and poor employment figures lean towards a cut, it is uncertain whether these indicators will alleviate or exacerbate the existing tension between the White House and the Fed.

The fourth issue is the sustainability of the strength of emerging market currencies, particularly the peso. Since the strength is linked to the poor U.S. macroeconomic indicators, if the indicators reverse again or if geopolitical risks (Middle Eastern situation) resurface, it is difficult to exclude the possibility that emerging market currencies, including the peso, will return to weakness.

II. In-Depth Issue Analysis

The Decline in U.S. Retail Sales and Consumer Sentiment, Signals of Economic Slowdown in North America: In-Depth Issue Analysis

1. Fundamental Cause Analysis

The primary cause of the sharp decline in retail sales in July is the base effect. The consumption boom until June was a result of large-scale tax refunds. As these refunds have been exhausted, consumption capacity has diminished accordingly. This is closer to the disappearance of a one-time fiscal transfer effect than a structural consumption recession. However, this interpretation alone does not adequately explain the concurrent decline in consumer sentiment indicators.

The reason for the decline in the University of Michigan's Consumer Confidence Index is different from that of retail sales. The survey team specified that concerns about tensions in the Middle East leading to rising living costs were a contributing factor to the decline. In other words, it was not a decrease in real income, but rather a deterioration in expectations regarding future prices that pulled down the sentiment indicators. At this point, the two indicators point to the same conclusion—namely, the possibility of consumption contraction—through different paths.

This is compounded by a cooling labor market. In July, non-farm employment decreased by 23,000, and the combined figures for May and June were revised down by 103,000. The average monthly increase in employment over the past 12 months has only reached 34,000. This indicates that the wage income base, which is the source of consumption capacity, has already been shaken. As the temporary stimulus factor of tax refunds has been removed, the underlying employment weakness has been directly reflected in the retail sales figures. EAI has previously characterized this as a "crack in the economic recovery narrative of the Trump administration." The retail sales and consumer sentiment indicators confirm that this crack is not an isolated indicator but a chain pattern.

2. Structural Context

Political Structure

With the midterm elections in November 2026 approaching, the poor economic indicators are directly impacting the Trump administration's political costs. When both employment and consumption indicators are shaken simultaneously, the narrative of the success of the tax cuts and tariff policies promoted by the White House loses its footing. The fact that the legal basis for tariff policy is continuously shifting from national security to balance of payments and forced labor responses also illustrates the instability of this narrative. PIIE has projected that the latest legal basis for tariffs is unlikely to be upheld in court.

Economic and Monetary Policy Structure

Price indicators are sending conflicting signals. The consumer price index for July rose by 3.4% year-on-year, slightly down from 3.5% in June. Wholesale prices also showed a greater-than-expected slowdown, with falling energy prices identified as a primary cause. El Financiero evaluated these indicators as signals that "ease pressure on the Fed." If inflation re-acceleration concerns are not significant, and if employment and consumption indicators are both weak, the Fed is likely to lean towards an interest rate cut at the September FOMC. In an interview with NPR, PIIE's Jed Kolko directly mentioned concerns about the poor employment report. The expectation of monetary policy easing is immediately transferred to a weaker dollar and stronger emerging market currencies.

Foreign Exchange Market Structure

The movements of the Mexican peso illustrate this structure. On August 10, the peso weakened to 17.14 pesos per dollar due to risk aversion stemming from geopolitical concerns. However, after the announcement of the slowdown in wholesale prices on August 12-13, the trend reversed, and the peso approached the 16 peso mark. The Philippine peso also showed signs of rebounding during the same period due to the weak U.S. employment figures. This is not a unique factor of individual emerging market currencies, but rather a common pattern that moves in response to poor U.S. macroeconomic indicators. The traditional structure where expectations regarding the Fed's policy rate path determine the direction of emerging market currencies has been reaffirmed.

3. Historical Precedents and Comparisons with Similar Cases

This case presents the issue of the time lag of fiscal stimulus effects due to the consumption decline following the exhaustion of tax refunds. The pattern of temporary fiscal transfers providing a temporary boost to consumption, followed by a sharp drop in indicators as that effect dissipates, has been repeatedly observed after past economic stimulus measures. However, in this case, the timing of the decline coincides with poor employment indicators and uncertainties regarding tariff policies, giving it implications beyond a simple base effect.

The pattern of changes in expectations regarding monetary policy leading to the strength of emerging market currencies was also observed during the early Trump administration in 2017. At that time, EAI's issue briefing assessed that changes in U.S. monetary policy were "foreseen," but also pointed out that given the instability across multiple areas of the Trump administration's economy, diplomacy, and politics, more cautious policy choices were necessary. Even then, the tension between fiscal expansion policies and the direction of monetary policy was identified as a factor increasing exchange rate volatility. EAI's assessment that the likelihood of repeated tensions between the Fed and the White House is high suggests that this structure is being reenacted.

4. Key Variables in the Development of the Issue

The most direct variable is the September FOMC. With the slowdown in wholesale prices increasing the likelihood of an interest rate cut by the Fed, the additional employment and price indicators to be released at the end of August and early September will be crucial in determining whether this possibility is confirmed. If a cut is realized, the trend of a weaker dollar and stronger emerging market currencies is likely to be maintained for the time being.

The second variable is the situation in the Middle East. Given that the direct cause of the decline in the University of Michigan's consumer sentiment was concerns about rising living costs stemming from the Middle East, the trajectory of consumer sentiment, oil prices, and inflation could move together depending on whether the regional situation worsens or improves. Daily Sabah has assessed that so far, the impact of rising oil prices due to the Iran war on broad inflation has been limited, but this judgment could be reversed at any time depending on the developments in the situation.

The third variable is the legal status of tariff policies. If the continuous changes in the legal basis for tariffs and the PIIE's projection that the latest legal basis is unlikely to be upheld in court materialize, one uncertainty affecting corporate investment and employment decisions will be resolved, but the financial calculations relying on tariff revenues will be shaken. This is a variable that will impact both future consumption capacity and fiscal policy space.

The fourth variable is the overlap of the midterm election schedule and the timing of economic indicator releases. Depending on whether the monthly employment, consumption, and price indicators released ahead of the November elections support or deepen the White House's economic narrative, the intensity and speed of policy responses may vary. The current trend is tentatively assessed to lean towards the latter.