Whither the consumer. While consumer spending has downshifted in recent months, most economists anticipate a rebound soon on the strength of the robust job market and high confidence levels registered by the surveys closely watched on Wall Street. But a few observers are beginning to suggest that a more important downturn is under way, sparked in part by elevated consumer debt, high real interest rates, and exhaustion of demand. If so, the current economic expansion-now in its seventh year-could soon lose steam, since consumer spending generates roughly two-thirds of economic activity. "Many analysts believe the fundamentals are so positive that the consumer is likely to engage in a burst of spending at any moment," said Lacy H. Hunt, the veteran economist and partner in Hoisington Investment Management Co., Austin, Tex. But he said the slower spending in the first half of the year may actually have been due to a peaking of the consumer credit cycle, a downturn in demand, and the de facto rise in interest rates in real terms as inflation has receded. How high are real rates? "Way too high relative to historic norms," said Bruce Steinberg, chief economist at Merrill Lynch & Co. Even after the latest rally, "a substantial inflation premium remains embedded in bond yields," he said. Ten-year Treasury securities are currently yielding 6%, or 370 basis points above the consumer price index. "Back in the 1950s, the 10-year Treasury yields averaged 3.4%, or 110 basis points above the CPI," Mr. Steinberg said. "And in the 1960s, the yield on the 10-year averaged 4.7%, or 220 basis points above the CPI." Meanwhile, the inflation rate recently has been very much akin to price increases of the 1950s and 1960s. But Mr. Steinberg, who thinks consumer spending may rebound, said he expects rates to fall further versus inflation. But he does not think real rates will return to earlier levels, at least while the economy is growing, "because of profound changes in financial intermediation and regulation." Mr. Hunt said he thinks the inflation trend is consistent with the tepid consumption pattern of the first half. "Business firms either complain of a lack of pricing power or adverse pricing conditions-which indicate a sluggish, not a free-spending, consumer," he said. "If the consumer were throwing caution to the wind, producers somewhere would be raising prices, or at least not cutting them," he reasoned. He said he believes the apparent contradiction between the strong fundamentals of consumer optimism and stock market wealth, on one hand, and sluggish consumer spending, on the other, may result from a trio of factors. First, less favorable conditions for borrowers. Consumer installment debt hit another new peak of 21% of after-tax income in April, he noted, and lenders are now cutting back by raising rates and fees and tightening underwriting. "The flow of credit to consumers in this cycle has peaked and is subsiding," Mr. Hunt noted. "This is reducing the availability of credit for everything from credit card purchases to new and used vehicles." Second, pent-up demand for cars, computers, and possibly even houses is sated after the long economic expansion. This helps explain turning points in business cycles, he said. "In the late stage of recessions, and early periods of recoveries, consumer spending strengthens even though income is falling," he said. That is because purchases have been postponed and many items must be replaced. "The opposite, of course, occurs in late periods of business expansions." Finally, he noted, real long-term interest rates in the first half of the year were among the highest in the past decade. In fact, real rates rose as the inflation rate receded. This is a powerful force restraining further growth of consumer debt, he said, and suggests "that top-line economic growth will be muted."

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