Americans are now forced to spend a large and rising portion of their disposable income on necessities: food, fuel and debt service. Such expenses now require 31.5% of disposable personal income (DPI), the most in 25 years. While outside factors may also affect consumer sentiment (red line), it closely tracks spending on necessities (blue line). As prices for such items rise faster than income, less money is left over for everything else and confidence drops.
Both measures are now back to levels last seen in 1982-83 (click to enlarge).
Unless retail prices for necessities soon reverse dramatically (unlikely), or incomes rise faster than food and fuel inflation (even more unlikely), consumers will stay on the defensive. They will continue to cautiously reduce discretionary spending and thus pressure the overall economy, which is now running on "slow crunch time". All those expecting a quick turnaround in 2008 had better adjust and learn to be patient.
There is an added dimension to this picture: the possibility for increasing demands for higher wages and salaries, to make up for lost purchasing power. If this situation continues unchecked for several more months, I wouldn't be surprised to see a resurgence in union activism, particularly in sectors where lower incomes predominate, e.g. retailing, food service and social services.
Therefore, crunch time applies to the Fed, too. The threat of structural inflation, not seen in a very long time, is already posing a serious challenge to the Fed's current policy. Highly negative real interest rates (Fed Funds at -2.00% now) may facilitate the salvage of the shadow banking system, but they also create inflation where it is felt the most by those that can afford it the least: essential food and fuel goods.
Tough choices ahead for the Fed.