The Federal Reserve warned that higher energy costs, softer consumer spending and uncertainty linked to the Middle East conflict were weighing on sentiment and adding fresh pressure to inflation, even as the U.S. economy continued to grow across most of the country in recent weeks.
In its May Beige Book report, the Fed said economic activity rose at a slight to moderate pace in 10 of its 12 districts, while one district reported no change and another posted a slight decline.
The report, based on information collected through May 27, said business expectations for the next six months showed little change in anticipated growth as companies faced elevated uncertainty and signs of weakening consumer demand.
Energy costs keep inflation pressure alive
The Fed said prices increased at a moderate to strong pace overall, with most districts reporting stronger inflation than in the previous report as higher energy costs fed into broader price pressures across the economy.
The pressure stretched well beyond gasoline, with businesses reporting higher costs for shipping, packaging, groceries and fertilizer, while agriculture, manufacturing, transportation and construction firms said fuel and petroleum-related expenses were squeezing margins.
The Fed said non-labor input costs continued to rise faster than selling prices, leaving many companies caught between higher bills and customers who were increasingly reluctant to pay more.
That pressure shaped how firms responded to the latest cost shock, with many businesses adjusting supply chains, changing product lines, cutting offerings or absorbing part of the pressure to protect demand rather than passing through every increase at once, a sign that inflation remains a risk as parts of the economy lose momentum.
Consumers show strain as spending splits by income
Consumer spending remained mixed across the country, with the Fed pointing to a sharper divide between higher-income households and those with less room to absorb price increases.
Higher-income consumers remained resilient and less sensitive to price changes, helping support demand for premium goods and services.
Middle-income households, however, were described as stretching budgets further before spending, while lower-income consumers showed greater financial strain.
The report cited increased credit card use, fewer retail visits and stronger demand for necessities, signs that households were becoming more defensive. Auto dealers also reported softer demand for new vehicles as affordability concerns and fuel costs pushed some buyers toward used and hybrid models.
Cautious hiring reflects a slower-growth mood
Labor markets held steady, but the Beige Book suggested companies were becoming more selective as uncertainty clouded the outlook.
Employment showed little to no change in 11 districts, while one district reported modest growth. The Fed said many contacts described a “low-hire, low-fire” environment, with employers filling only critical roles or replacing workers lost through attrition rather than expanding aggressively.
Wage growth was generally modest to moderate and broadly in line with inflation, though some businesses made more frequent pay adjustments or cost-of-living increases to help workers manage higher fuel and household expenses.
Manufacturing hiring was one of the brighter spots, supported by defense-related activity and rising data center demand.
Data centers and defense cushion the factory sector
Manufacturing remained a key source of support for the economy, with activity increasing at a modest to strong pace in nine districts.
The strength was driven in part by demand linked to data center construction, defense spending, energy infrastructure and related equipment, while several districts reported stronger orders for metals, machinery, electrical components and other products tied to those projects.
Even so, the factory sector was not immune to the broader pressure. Some manufacturers said higher input costs, tariff uncertainty, supply-chain disruptions and weaker consumer demand were affecting orders, while others suggested that booming data center activity was covering weakness elsewhere.
Fed report points to growth with rising risks
The Beige Book leaves policymakers facing a mixed picture: the economy is still expanding, but the drivers of growth are becoming narrower, inflation pressure remains difficult to contain and consumer demand is showing cracks.
For the Fed, the report suggests that the Middle East conflict and the resulting energy shock are not only pushing up prices, but also testing household budgets, company margins and confidence across the economy.