Americans are about to put the brakes on spending, and that's got Wall Street analysts on alert. Here's why, and what it means for stocks.

• Americans are beginning to tighten their belts in the face of inflation and rising interest rates.
• The slowdown in spending might come quicker than the Fed expects, and it could signal a recession.

Americans look ready to start pulling back on spending, as the effects of inflation and rising interest rates finally begin to bite.

Retailers and others believe that consumer expenditure is likely to fall, after kicking off the first weeks of 2023 on the rise.

Over the past year, the Federal Reserve has raised interest rates from near-zero to almost 5%, in part to encourage saving over spending as it tries to cool red-hot inflation,

Consumer expenditure has proven remarkably resilient in the face of all that. Wage inflation has offset a good amount of the pain from price inflation, especially given the fast pace of job growth, according to Bank of America's Aditya Bhave.

"But when those dynamics slow down, even if price inflation comes down a little bit, you'll see consumers start to tighten their belts," the bank senior economist said.

The Fed might still stick with its aggressive monetary tightening, even so. It could spell a recession, and more turmoil for markets, some analysts say.

What's happening?

Economic data showed Americans were still out spending in the first weeks of 2023, long after the nearly three years after a historic spree began in the wake of stimulus packages handed out during the onset of the COVID-19 pandemic.

Bank of America analysts found household credit and debit card spending rose over 5% in the year to January. Meanwhile, the Fed's preferred PCE inflation gauge showed a 1.8% jump in consumer expenditure that month, compared with December.

That suggests the central bank's aggressive interest-rate hikes over the past year haven't cooled demand yet — a "very troubling" development that makes a recession more likely, according to former Treasury Secretary Larry Summers.

But the tide in spending could be turning.

Top retailers Target, Macy's and Best Buy have all said they are bracing for people to cut back on outlays in 2023, noting that shoppers are actively searching for discounts.

The latest US credit and debit card data for February also suggest spending is slowing down, Bhave told Insider.

Why?

American households are feeling the pinch of rising prices for everyday food items, and that may be making them think twice about opening up their wallets.

Target CEO Brian Cornell said his company was seeing a noticeable shift on the grocery store aisles.

"Spiraling inflation forced families to put discretionary purchases on hold and focus most of their spending on necessities," Cornell said in an earnings call.

David Marcotte, a senior VP at Kantar Retail, suggested broad-based price pressures aren't what's driving the shift.

"On the consumer side, they keep running into that one item that sticks in their head," Marcotte told CNBC. "Right now, eggs — which I can't imagine — eggs as the big item. That's what they're benchmarking."

It's fair to say most analysts weren't expecting consumer spending data to be so resilient in January — and some suggest those figures might be overblown.

Ryan Sweet, chief US economist at Oxford Economics, said there were some factors last year that meant the uptick in expenditure could be a "flash in the pan". They include the milder weather and cost of living adjustments.

"I think the February and March data will most likely be much weaker than what we saw in January, from a consumer spending perspective," Sweet told Insider.

Meanwhile, Wells Fargo calculates that Americans have 10 months of spending power left, if they keep tapping their savings at the current rate.

But Sweet thinks that data could be misleading, as it's mostly being hoarded by wealthier households who are unlikely to spend it like those on lower incomes.

What does it mean for markets?

A dip in consumer spending might signal the beginning of a sustained drop in demand in the US. But there are concerns that the fall might come faster than the Fed expects.

The central bank's higher rates have pulled down asset prices, sending stocks lower as they ultimately mean less profits for corporations. The major US equity indexes slumped in 2022 as investors grew concerned the Fed would tip the economy into recession.

"The Fed will be fine with a slowdown in the consumer, even to the extent of what we're seeing," Bhave said, noting Bank of America expects a mild recession in the third quarter of 2023.

"They're not going to officially say that they want to cause a recession. But they have essentially indicated that they would be okay with the recession, because that's how you get inflation back down to 2%."

Sweet worries the wave of positive yet temporary data has made Fed Chair Jerome Powell overly jittery about inflation.

He expects three more 25 basis point hikes this year, but hasn't ruled out a "shock and awe" moment of a 50 basis point rise at policymakers' next meeting.

"They're gonna break something. They're gonna break inflation, which is their goal. But unfortunately, they may break the economy as well," Sweet said.

"That's a big risk to the forecast — that the Fed goes more aggressively than what either markets or we are anticipating, and that pushes us into a mild recession."