The broad economic environment in the United States today is anything but normal. We are living in an era when unemployment is near historic lows and consumers have excess savings while at the same time interest rates are increasing rapidly and both the banking and financial markets are unsettled. In all my years of forecasting, it has never been so challenging to put together the pieces of the economic puzzle and connect them to where the economy is heading. And the disruption and uncertainty are likely to persist.
Aggregate economic activity has held up well despite restrictive monetary policy intended to curb inflation. The economy was resilient in the second half of 2022, with gross domestic product growing nearly 3% even as interest rates rose. I believe we will likely skirt a recession this year, but with rates continuing to increase, I have assumed in preparing NRF’s 2023 retail sales forecast that GDP growth will slow to less than 1%. The outlook is clouded by the recent disorder in the banking sector, but I am hopeful the forecast is correct and I would need to see more hard data before changing my view in either direction.
The forecast is predicated on the assumption that the U.S. banking system is “sound and resilient” as purported by the Federal Reserve and that the Fed will be able to quell the banking sector turmoil and bolster confidence. Recent Fed and Treasury Department programs have stabilized the banking system and market volatility. Even so, the Fed says recent developments are likely to result in tighter credit conditions and affect economic activity, hiring and inflation, although “the extent of these effects is uncertain."
We have had one of the most rapid increases in interest rates ever seen during the past year but the moves haven’t slowed the economy as much as might have been anticipated. The Fed has raised its short-term rates five percentage points since early 2022 but we still see strength in the economy and the increases haven’t cooled the labor market. Nonetheless, I don’t believe the full effect of tightening has shown up. Monetary policy works with long and variable lags, and it's too early to know the true effect of interest rate hikes on the base of the economy.
Consumer spending on goods and services accounts for around two-thirds of economic output and is the primary driver of growth. What is surprising in this uncertain environment is how consumers have had uncanny staying power. Consumer spending for the first two months of 2023 was relatively strong, suggesting that the economy continued to expand in the first quarter despite higher borrowing costs. Spending has been supported by strong job and wage growth, a stockpile of savings built up during the pandemic, access to credit, and lower energy costs.
U.S. retail sales point to the underlying strength of consumers. Sales as calculated by NRF – excluding automobile dealers, gasoline stations and restaurants to focus on core retail – showed an average growth of 6.6% for the combined months of January and February unadjusted year over year. Looking forward, our annual forecast predicts that retail sales will grow between 4% and 6% during 2023 compared with 2022. That is a decelerated pace compared with the 7% seen in 2022, but still above the pre-pandemic average of 3.6%.
While not as much as expected, higher interest rates are having an impact. Consumers remain resilient, but higher rates have weighed on housing, trade and business investment. Nonetheless, inflation continues to take a toll on the economy and remains significantly above the Federal Reserve’s 2% target. A key argument is about the speed of inflation coming down – too slow can provide too little relief while too fast runs the risk of a recession. Measuring inflation is difficult, it’s even harder to forecast, and few forecasters have gotten it right. Inflation figures tend to come out slowly and can contradict one another, making it difficult for individuals and businesses to budget and plan with confidence.
Recent strong labor and economic activity is maintaining upward pressure on inflation, but the numbers are falling. The Personal Consumption Expenditures Price Index – the Fed’s preferred measure of inflation – was up 5% year over year in February, compared with 5.3% the preceding two months and a peak of 7% last June. Inflation is a critical consideration in the 2023 retail sales forecast, and we have assumed that it will average between 3% and 5% for the year, or about half the pace experienced in 2022. With pandemic lockdowns long gone and consumers comfortable venturing outside the home again, inflation is higher for services ranging from restaurant meals to airline travel than for retail merchandise. This has been reflected in the PCE index for services, which increased from 5.6% in January to 5.7% in February while the PCE index for goods declined from 4.7% to 3.6% for the same period.
This is not one monolithic economy and as we move forward there will be state and regional variations given the industrial base and demographics. We have already seen mass tech sector layoffs, and housing was the first sector to take a hit in 2022. For the retail industry at large, there are challenges ahead, but I believe the industry as a whole is more resilient having survived the COVID-19 crisis. The industry resized between 2011 and 2020, making investments in operational changes and online capabilities. While retail job openings have fallen, they remain high, and the shortage of retail workers continues.
The year ahead will be a bumpy journey. Consumer confidence, especially with banks, needs to be maintained in order to sustain spending in these uncertain times. The wildcard is what the Fed will do with interest rates in the coming months. Tighter financial conditions are an imminent risk that could lead firms to rein in hiring plans and dampen the flow of income that fuels households’ appetite to spend. As always, striking the right balance is the key – and the challenge.