US economic activity has expanded modestly while inflationary pressures driven by energy price increases have clouded the economic outlook (since mid-April), as per the US Fed's Beige Book published on Wednesday.

Most regions experienced higher inflation from late April to late May. Higher energy costs stemming from the conflict in the Middle East are putting heavier financial burdens on shipping, packaging, groceries, and fertilizers, the report on current economic conditions across the 12 US Federal Reserve Districts stated.

Fractured consumption and manufacturing pressures

Consumer spending shows a fractured performance amid stresses. Signs of financial strain have persisted since the last survey in April, showing diverging affordability pressures across different income groups. High-income households remain resilient. Middle-income households are forced to stretch budgets to sustain spending—"squeezing more life out of every dollar"—while low-income consumers face heavier financial constraints. The survey found increased patterns of credit card usage, fewer retail visits, and stronger demand for necessities—a disturbing signal for the key driver of the American economy.

Manufacturing activity remains split across sectors. A manufacturing firm told the Boston Fed that increased shipping costs have cut into profits, and they also faced higher raw materials costs. While AI-driven investment fuels some factory expansion, most manufacturers grapple with rising cost headwinds, turning the AI-related boom into a double-edged sword.

More companies are investing in infrastructure and data centers while cutting off early-level hiring, marking a potential structural shift in the labor market. Fed banks also noted that more frequent wage adjustments and cost-of-living increases to offset surging fuel and household expenses could fan fresh inflationary pressures.

The PCE price index, the Fed's key inflation gauge, rose 3.8% year-on-year in April, registering the biggest jump since May 2023.

Tricky road ahead for the FOMC

Economist Heather Long has warned that inflation is turning sticky, putting the new Fed Chair in a policy bind. While AI-fueled investment delivers tangible growth gains, persistently elevated prices restrict room for monetary easing, according to a report by Reuters.

The latest ISM readings also point to lingering elevated raw material costs across US manufacturing, with the prices index holding above 80, well above the 50 threshold for stable costs, signaling a widespread rise in manufacturers' input costs and headwinds across the sector.

Dallas Fed President Lorie Logan warned that higher benchmark rates may be required in late 2026 amid sticky inflation, heightening uncertainty over the Fed's monetary policy path.