U.S. consumers are feeling the cost of living squeeze amid higher housing costs, slower wage growth and rising unemployment fears, raising concerns about how much longer they can keep spending on discretionary items.

While the labor market has provided a cushion thus far, cracks are emerging, testing the resilience of household budgets and their ability to sustain the broader economy.

In a report released Thursday, Joe Wadford, an economist at the Bank of America Institute, said that while overall consumer spending remains resilient, financial headwinds are mounting—particularly for lower-income consumers.

“Consumer resilience continues, but cost-of-living increases, slowing wage growth, and unemployment fears are a headwind for some,” Wadford said.

Housing Costs Are Squeezing Budgets

The biggest challenge for many households is the rising cost of housing, which is hitting lower-income consumers the hardest. According to Bank of America payments data, rent and mortgage payments for this group were up 11% in February compared to the 2023 average, while higher-income customers saw a smaller increase of 9%.

“It's likely that lower-income consumers are getting hit harder as apartment rental increases spread to less expensive areas,” the report said.

Higher-income households may be faring better because “homeownership tends to skew toward higher-income individuals, and monthly mortgage payments typically do not change over time.”

For lower-income households, housing is their largest expense, consuming nearly half of their after-tax income, followed by transportation, groceries and utility bills.

“These expenses account for around 95% of their after-tax income,” Bank of America data revealed, leaving little room for discretionary spending.

Consumers Have Slightly Cut Back Spending

Despite rising costs, discretionary spending—on goods such as electronics, travel, and restaurants—has remained relatively stable over the past year.

Bank of America's payments data shows that while spending on these items has declined compared to two years ago, the rate of decrease has slowed.

“Customers with lower incomes spent a higher share of their paychecks on necessities and have seen a larger decline in discretionary spending over the past two years than other income cohorts,” the report said.

Yet, the report highlighted that the rate of decline has more than halved in the past year, with discretionary spending as a share of total outflows falling by just 0.3 percentage points in February, compared to a 0.8 percentage point decline the previous year.

Discretionary-related stocks have struggled this year. The Consumer Discretionary Select Sector SPDR Fund ( XLY ) , which tracks major names like Amazon.com Inc. ( AMZN ) , Tesla Inc. , Home Depot Inc. ( HD ) , and Booking Holdings Ltd. , is down 11% year to date, underperforming all other S&P 500 sectors.

The Labor Market Is Holding Up, But Cracks Are Emerging

A strong labor market has helped sustain consumer spending so far, but that is not warranted to be the case also in the future.

Households across all income levels have seen post-tax wages and salaries rise year over year. While deposits are declining, “they're not declining as fast as they were last year,” according to Bank of America data.

Signs of weakness are emerging. The U.S. unemployment rate stood at 4.1% in February, higher than in previous years, and consumer expectations around job security have deteriorated.

In its March economic projection, the Federal Reserve upwardly revised the unemployment rate from 4.3% to 4.4% for 2025.

The University of Michigan's Survey of Consumers found that 66% of respondents in March expect unemployment to worsen over the next 12 months—the highest share in the past 10 years.

“It's 14% higher than it was in the first two months of the COVID-19 pandemic,” the report highlighted, suggesting that consumer fears about job losses could soon impact their spending decisions.

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