The Federal Reserve's efforts to fight inflation through higher interest rates have left US consumers disgruntled with their finances and spending power.

While the latest inflation reading is far below its most recent peak, rising prices were the greatest threat to consumers' personal finances, according to S&P Global Market Intelligence survey data released in February. Energy and healthcare costs, along with elevated interest rates, are also among consumers' top concerns.

Consumers' attitudes toward their finances do not fully reflect a US economy marked by persistent wage growth, unemployment near historic lows and an oft-predicted recession failing to materialize. The trend also reflects the lingering impact of sharp price and rate hikes, all adding to day-to-day costs.

"While inflation has gone down, consumers are seeing and spending higher real dollars," said Michael Nocerino, a research analyst at Market Intelligence.

Discretionary purchases on the chopping block

One way consumers have altered their spending habits is by dialing down their discretionary spending, widening the gulf between non-discretionary and discretionary categories. The net balance of consumers saying they expected to spend more on non-discretionary items over the next three-month period stood at 34%, compared to a net balance of 10% saying they anticipated to spend less on discretionary purchases, according to Market Intelligence data.

"Consumers are generally focusing their spending plans on non-discretionary items, because even if sentiment is low — they still have to go out and buy certain things to keep their households going," Nocerino said. "Some of it is out of necessity. If someone spends a large portion of their household budget on energy and groceries, they may not necessarily have much left to even consider discretionary purchases."

Thinking twice about spending decisions is leaving a considerable mark on consumer confidence. While it has risen from its summer 2022 lows, the University of Michigan's consumer sentiment index is still 26 points below where it was before the COVID-19 pandemic. Another University of Michigan survey that measures consumers' views of their financial situation compared to a year earlier shows consumer confidence is 46 points below where it was in February 2020.

Consumer confidence is being hurt by prices that are well above pre-pandemic levels and the price increases for "high-frequency purchases," such as food and gasoline, which have outpaced broader inflation and average wage gains, said Shannon Seery Grein, an economist with Wells Fargo.

"When consumers go to the grocery store, they still feel the heat from higher prices," Seery Grein said. "Inflation may be slowing, but prices are not falling."

Mortgage and other loan rates are soaring

Consumer sentiment is also being hurt by borrowing costs remaining at their highest levels in decades, economists with the International Monetary Fund and Harvard University said in a working paper released in February.

In February 2020, the average American worker earned $28.55 an hour. Four years later, the average worker makes $34.57 an hour, a more than 21% jump and one of the most significant wage increases in US history.

But the cost of money, via higher rates for mortgages, auto loans and credit cards, as well as an increasing reluctance by banks to finance purchases, is weighing on consumers and their views of the cost of living.

"It is not surprising that this would affect how consumers feel about the economy," the IMF and Harvard economists wrote.

Mortgage rates have soared since the Federal Reserve began its hiking campaign in March 2022, with the 30-year fixed-rate average climbing to about 7.8% in October 2023, its highest level since 2000.

"The real estate market and demand for big-ticket items are being disproportionately affected by higher rates and tighter credit conditions," said Gregory Daco, chief economist at EY-Parthenon.

The 30-year average rate stood at nearly 6.9% in early March. This means that consumers buying a $425,000 house with 20% cash down would pay about $2,581 a month in mortgage payments, up from the $1,716 monthly payment the buyer of the same priced home would pay in early 2021 when rates were at 2.65%. The difference amounts to $311,400 during the life of the loan.

High interest rates have chilled the housing market, with existing home sales dipping to levels not seen since 2010, causing a ripple effect throughout consumer spending, said Michael Zdinak, an economist who leads the US consumer markets service at Market Intelligence.

"As housing goes, so goes the share of consumer spending on housing: furniture, furnishings, décor and even renovations," Zdinak said.

The average rate on a loan for a new car jumped to 7.48% in 2023 from 3.92% in 2021. Payments have risen by $91 per month in just two years, according to an analysis by Experian, a consumer credit reporting company.

Credit card interest rates have also risen to record highs, with the average consumer paying 22.8% on their balance at the end of 2023, up from 12.9% a decade earlier.

"There's no question that high consumer interest rates right now are a concern for households and are weighing on some parts of the consumer economy," said Augustine Faucher, chief economist of The PNC Financial Services Group.

As long as inflation remains above the Fed's 2% target, delaying any rate reductions, consumers will continue to spend cautiously.

"The longer higher rates prevail, the more they will take a bite out of consumers' willingness to spend," said Oren Klachkin, a financial market economist at Nationwide. "This will be especially true in [the second half] of 2024, when we think the labor market will show greater signs of weakness."