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It’s clear from the better-than-expected May retail sales data that Americans are spending their federal stimulus checks. And it’s equally clear that the spending is coming sooner than expected, which could mean a sharper slowdown in the fall - just in time for a hike in the Fed funds rate.

A highly-publicized campaign and a U.S. Treasury that moved the money out faster have caused spending to rise more than originally expected, analysts said, with consumers in some cases spending the cash before they even got it.

Retails sales jumped 1% in May, above the consensus for a 0.5% rise - and April’s data were revised to a 0.4% increase from a 0.2% decline.

Lehman Brothers estimates that just under half of the government’s $106.7 billion in tax rebates was delivered in May, and about 40% will be spent on goods or services over the next few months.

“Some will claim ‘resilience’ on the part of the consumer, but we view it like this - give the American consumer free money, and they will spend it,” said economist David Rosenberg, of Merrill Lynch.

Few observers, if any, viewed the government cash as anything but a temporary boost, with many estimates pointing to higher third-quarter spending and GDP growth in the third and fourth quarters.

If consumers spend 50% of the rebates, with about two-thirds of that showing up in core retail sales, “then it is quite likely that retail sales will be slumping three to six months from now, or at least underperforming the trend by a wide margin,” according to Goldman Sachs.

And then what? Will the consumer feel better? Not with home prices falling, gas above $4 a gallon and consumer sentiment dipping.

Consumer sentiment fell for the fifth consecutive month to its lowest level in almost three decades, to 56.7 in early June from a reading of 59.8 in late May, and beneath the consensus of 59.8 from a survey of economists polled by Thomson’s IFR Markets.

“Consumers spent more in May, buying food, shirts and gadgets, but they didn’t feel any better about their economic condition,” said Rosenberg.

If the effect of the stimulus wanes, which may dim expectations of a rate hike in September, the anti-inflation and strong dollar comments from Fed speakers in recent weeks is pointing the other way. The Fed funds futures are forecasting that a 25-basis point rate increase is more likely than not when the FOMC meets in August.

That’d be a rate hike to curb inflation for consumers who’ve already spent their free money.

A frequent complaint of Empire Staters is that New York has one of the highest tax rates in the nation. Those dissenting voices are apt to get a little louder now, as a law signed by Governor David Paterson created a sales tax for online purchases, making New York one of the first states to have such a plan.

There’s an old saying that no tax is a good tax, so there’s no surprise that online retailers Amazon and Overstock have already filed lawsuits challenging the tax, claiming it unconstitutional. But legality aside, will the tax really have much of an effect on online purchases in the state, which accounts for about 6% of total U.S. sales?

The measure is expected to raise about $50 million; a paltry sum as far as the budget goes, especially for a state as heavily populated as New York. In a research note, Deutsche Bank speculated that the new tax would only have a minimal tax on most online retailers, though it could pose a bigger issue for high-end luxury retailers.

The firm estimated that the impact of the law would be less than a penny a share for most companies in 2009, and that it wouldn’t impact online retailers by more than $1 in equity value. This is even if spending slows and some customers cease online purchases, an outcome Deutsche Bank doubts. “Because we estimate Amazon’s average order value to be in the $50-$60 range,” it said, “we don’t expect consumers to radically pull back on the spending, given taxes, on a dollar basis, is immaterial.”

The minimal impact for smaller orders goes to explain why Deutsche Bank sees bigger repercussions for such high-end retailers as Blue Nile, where the estimated average ticket value is $1,600. “Items with a higher basket value could cause incremental hesitation in shopping behavior, especially if tax becomes a factor in the shopping process,” the firm wrote. “With the backdrop of a tough consumer spending environment and a likely curb in luxury goods spending, we estimate 25% of consumers could choose alternatives through traditional channels.”

The firm expects that Blue Nile’s 2009 earnings could take a hit of 2 cents a share from the tax, despite New York’s reputation as a “tier-two city” for the company’s sales (Blue Nile’s biggest markets are San Francisco, Austin and Boston).

The full impact of the tax is yet to be seen, but it’s likely that if online sales don’t slow too much, other states may try and legislate similar taxes. This would only heighten the constitutionally question. Deutsche Bank didn’t go so far as to say it was unconstitutional, but it did say that it “certainly goes against the grain of Quill Corp. vs. North Dakota, as it leaves open the idea that any affiliate, rep, agent, salesperson that steps into the state will create a tax nexus for a company.”

Thanks to the federal government’s $168 billion economic stimulus package, more than 130 million U.S. households will be wealthier by the end of June. The question is, what will consumers do with their new-found cash?

According to a recent Cowen & Co. survey of more than 1,000 people, specialty retailers banking their second-quarter outlooks on inflows from rebate funds may be out of luck. “We believe expectations for tax rebates to stimulate specialty retailers spending are overstated,” analyst Lauren Cooks Levitan said in a note to clients. Levitan said the study’s results suggest that rebate funds will be used primarily to pay bills or purchase essential items, having only a limited effect on specialty retailers as compared to mass merchants.

The average respondent intends to spend just 15.4% of a refund on non-essential items, according to the survey, and 65% of respondents do not intend to buy any non-essential items at all with a refund.

Another key takeaway from the survey was that discount stores are the most likely destination of consumer’s rebate funds, following by big-box superstores. That’s great news for the likes of Wal-Mart, which has at least one Wall Street analyst speculating that the company’s second-quarter earnings guidance of 78 cents to 81 cents a share could prove conservative given that it doesn’t take into account rebate spending. That could be even better news if wal-Mart has plans to provide additional incentives to shoppers spending their tax rebate in the store, the study suggested, because 45% of respondents indicated they would be very likely or likely to shop at retailers doing just that.

Consumers’ overall plans for the tax rebate dollars were also in line with their answers regarding recent shopping patterns, which highlighted that 39% of consumers surveyed said they are shopping less at full-price retailers and more at discount stores than they did one year ago. Going even further, 54% of respondents said they are making fewer purchases at full price and buying more items on sale - even 41% of higher income households ($100,000+) indicated they are making fewer full price purchases.

“While we are encouraged by progress made by many specialty retailers in lowering inventories and expenses to provide some downside protection against weak sales, we believe the current expectations embed improved overall retail and consumer trends in the second half of 2008, partially boosted by the anticipated benefit of tax rebates, which our survey indicates could prove overly optimistic,” Levitan said.

U.S. consumers are on the verge of the worst downturn since the 1970s, but not everyone stands to get hurt.

A Citigroup analyst Tuesday recommended that investors buy shares of Wal-Mart Stores Inc. and Kroger Co., noting that the two retailers are “best positioned to gain share” in the current challenging economic environment as consumers become more value-conscious.

Analyst Deborah Weinswig said an “overwhelming” 72% of customers who participated in a Citigroup proprietary survey said that Wal-Mart had the lowest prices. Kroger had the next best pricing message, with 6.9% of customers saying it had the lowest prices.

In contrast, when asked which food retailer was the most expensive, 26.5% of consumers found Safeway Inc. to be the most expensive, while 24.5% of consumers found Supervalu Inc. to have the highest prices.

In the face of soaring food inflation and gas prices, Weinswig said consumers are also reining in their discretionary food purchases and “trading down” — where they shop (moving from Target to Wal-Mart), what items they buy (switching from steak to chicken), and which products they choose, branded or private label (buying more private label vs. national brands).

“We observed that 30% of consumers have purchased affordable substitutes (i.e. chicken instead of steak),” Weinswig wrote to clients. “Consumers have already adjusted their shopping habits, and we believe these changes could be the early signs of an additional pullback in consumer spending.“

It’s evident that Wal-Mart has already begun to see the benefit from its price leadership. Shares of the world’s largest retailer and Dow industrials component rallied to its highest level in three years Monday and have been up nearly 12% since the beginning of the year.

Earlier this month, Wal-Mart posted better-than-expected same-store sales for February, getting a lift from continued strength in the grocery, health and wellness and entertainment business segments. “With consumers increasingly concerned about their personal financial status and a higher cost of living, we will continue our commitment to price leadership across all categories,” said Tom Schoewe, the company’s chief financial officer.