Monthly Economic Review: February 2023

Sluggish growth expected in 2023
2023 February Monthly Economic Review

A month into 2023, the outlook for the economy is facing stiff headwinds and – with the exception of easing inflation – will likely face more challenges before it gets better. This is typical in the late stages of a business cycle, which usually includes ongoing inflation, slowing production and tightening monetary and financial conditions. The current economy reflects these characteristics and is likely to endure slow and possibly negative growth during the coming year. However, it will not affect everyone at the same time or in the same way, with different sectors likely seeing downturns at different times without a significant contraction across the broader economy.

The debate on whether we are in a recession will heighten over the next few months, just like last year. But while households will probably feel recession-like conditions this year, I do not expect that the downturn will be severe enough to become an official recession. It is up to the National Bureau of Economic Research to make that determination. And the bureau, which defines a recession as a significant decline in activity spread across the economy and not confined to one sector, moves cautiously, typically waiting weeks if not months to decide whether a downturn has met that definition. They examine factors such as payrolls and the labor market, real personal income, retail sales and industrial production. And even when the U.S. economy posted two consecutive quarters of negative gross domestic product figures in the first half of 2022, the bureau did not declare a recession because many of those factors did not see a decline. In fact, wages, payrolls and retail sales continued to increase despite talk of a recession.          

The most recent GDP data shows that the economy is more resilient than expected but is exhibiting a mild slowdown because underlying data is not as strong as it seems. Overall, the economy grew 2.1% in 2022 as a solid second half offset back-to-back quarters of GDP declines in the first half of the year. GDP for the fourth quarter increased at a 2.9% annual rate, down modestly from the 3.2% posted for the third quarter. The largest contributors were inventory increases and consumer spending, and nonresidential investment and government purchases were also noticeably positive. But those gains were partially offset by declines in exports and imports and a significant falloff in home building. Private final sales to domestic purchasers, a key measurement that focuses on underlying demand by both consumers and businesses, increased a skimpy 0.8 % in real terms after growing 1.5% in the third quarter.

The Federal Reserve’s monetary policy tightening is getting traction, and the GDP numbers show that the Fed’s interest rate hikes are having their desired effect. Clearly, interest-sensitive sectors of the economy, particularly housing, have been hit the hardest by the aggressive rate hikes. But industrial production also fell sharply in the final months of 2022, driven by a pullback in consumer demand for goods. And while consumer spending grew at an annual rate of 2.8% for the year, it was weak in December, declining a seasonally adjusted 0.3% after dropping 0.2% in November. Spending on goods fell 1.6% but services held up better, increasing 0.5% from November. Consumer spending is expected to slow in 2023 but not collapse.

Households were cost-conscious at the end of 2022, with overall retail sales in December dropping 1.1% from November as gasoline prices and sales of new automobiles fell sharply and holiday sales turned out to be choppy and slower than expected. Retail sales as defined by NRF – excluding auto dealers, gas stations and restaurants to focus on core retail – were down 0.5% month over month in December. Combined November-December holiday sales grew 5.3% over 2021 but fell short of NRF’s forecast for growth between 6% and 8%. January sales numbers aren’t in yet, but consumer sentiment proved resilient as shoppers appeared to be more upbeat about the economy, income and employment.

The weakened demand during the fourth quarter came as inflation declined but remained elevated. The Personal Consumption Expenditures Price Index – the Fed’s preferred inflation measure – eased to 5% in December, its slowest annual pace in over a year, from 5.5% in November. The core PCE index, which excludes volatile food and energy prices, was at 4.4%. Following those results, the Fed raised rates by only a quarter of a percentage point at its February meeting rather than repeating the half-point increase imposed in December. Another quarter-point hike is expected in March to bring the Fed’s rate to around 5%. The slowing momentum of inflation paves the way for a reassessment of further rate hikes and financial markets are looking for the Fed to begin easing interest rates somewhere in the middle of 2023. But even if inflation slows sufficiently to allow some easing, we expect policy rates to remain in restrictive territory.

The labor market is holding up but cooling as many large companies announce layoffs. The economy added 223,000 jobs in December while unemployment fell to a 50-year low of 3.5%, and new claims for unemployment insurance declined to only 186,000 during the week ending January 21. Some industries are under pressure to reduce costs and major tech firms, in particular, have cut employment, but not all companies are in layoff mode. According to the most recent National Federation of Independent Businesses report, small business owners plan to add positions as labor shortages remain. The driver of the U.S. economy is the consumer, and spending has been fueled by the stronger-than-ever labor market. That means concerns over job security and corporate belt-tightening could signal a significant pullback in consumer spending. Extensive backtracking in employment would be a critical issue that could signal the onset of a recession.

At this juncture, the economic outlook is particularly uncertain and data dependent. I continue to see a sluggish pace of growth in economic activity during 2023. Inflation remains a problem and the risk of a considerable falloff in growth is tied to monetary policy. The Fed appears to be in a wait-and-see mode and the policy direction over the next few months spans the range from status quo to sizeable increases in the federal funds rate. The U.S. labor market has shown signs of strength. The good news is that corporate and household balance sheets are in the best shape we’ve seen going into a downturn. This should make any economic slowdown mild and limit the downside risks despite my outlook for the economy to straddle a zero-growth path during 2023.

Past issues

Economy is Expanding but Momentum is Slowing
NRF Chief Economist Jack Kleinhenz says the economy is still growing, but not as fast as it was earlier this year.
Read more
Monthly Economic Review: September 2023
Economy is expanding but momentum is slowing.
Read more
Monthly Economic Review: August 2023
Economy remained resilient in first half of 2023 but pace is lessening.
Read more