Consumers and businesses alike are attempting to navigate 2022’s rapidly changing economic environment. The United States is in the grip of the highest inflation in 40 years and tightened financial conditions are beginning to restrict economic activity. Inflation has pushed the Federal Reserve to increase interest rates, dragged down stock and bond returns and impacted consumer confidence. Adding to the complexity of the situation, geopolitical unrest from the war in Ukraine continues to cause worldwide disruptions that are driving the sharp rise in energy prices and contributing to disruptions in supply chains.
The Federal Reserve took aggressive action to tame rapid and persistent inflation in June by raising the benchmark federal funds interest rate by three-quarters of a percentage point, the largest increase since 1994. That followed recent increases of one-quarter and one-half point as the central bank tries to achieve its goal without stalling the economy. The Fed is "strongly" committed to bringing inflation down and plans to lift its short-term rate to at least 3 percent this year. “It is not going to be easy,” Chairman Jerome Powell said. “We are not trying to induce a recession.”
The only way the Fed can fight inflation is to slow demand by making it more expensive for consumers and businesses to borrow money. The Fed increases will mean higher interest rates and higher monthly payments on home mortgages, car loans and credit card bills for consumers while businesses will see higher costs for corporate borrowing and the government will pay more on the $23.9 trillion in debt held by the public. The Fed’s latest forecasts show the federal funds rate at 3.4 percent by the end of 2022 and 3.8 percent by the end of 2023.
While economic data is softer than a few months ago, it still signals further solid economic growth. Job openings and quit rates through the end of April suggest the job market remains tight, payroll growth remains sturdy even though it slowed in May, and the unemployment rate has been steady at 3.6 percent for three months in a row. The most closely watched business survey on manufacturing – the monthly ISM Report on Business from the Institute for Supply Management – suggested that May activity inched up as supplier deliveries improved along with decent demand and orders, and order backlogs grew at a faster pace.
Consumer spending is still showing resilience despite rising prices. NRF’s calculation of retail spending, which excludes automobile dealers, gas stations and restaurants to focus on core retail, was expected to slow in May but was unchanged from April and up 6.7 percent year-over-year. For the first five months of 2022, retail sales were up 7.3 percent compared with the same period in 2021. The Federal Reserve Bank of New York’s Survey of Consumer Expectations says households expect inflation to rise 6.9 percent over the next year but only 3.9 percent over the next three years. Overall household spending – beyond just retail sales – is expected to pick up sharply, rising 9 percent next year for a new high.
As COVID-19 eases, households are rebalancing their spending and adjusting their shopping habits. Restaurant sales showed impressive month-over-month growth of 0.7 percent and year-over-year growth of 17.5 percent in May – activity that serves as a proxy for broader service spending in sectors such as recreation and transportation that have been on the upswing. Meanwhile, the Transportation Security Administration is seeing an increase in the number of travelers who are flying, with passenger volume approaching pre-pandemic levels. Over 40.3 million passengers passed through airport checkpoints between June 1 and June 17, only 12.5 percent below the same period in 2019.
The current economic expansion is more than two years old, lasting far longer than the intense-but-brief recession that ended in April 2020. That pandemic-driven downturn lasted only two months, making it the shortest U.S. recession on record, but it nonetheless met the National Bureau of Economic Research’s definition of an official recession – a significant decline in economic activity spread across the economy and not confined to one sector.
I am not betting on an official recession in the near term, but the most recent research pegs the risk over the next year at about one in three and it will be touch and go in 2023. In the meantime, a contracting economy short of a recession is not out of the question. If a recession does happen, it typically takes a long time to manifest itself – thus, the NBER typically waits several months as it examines a range of data including employment, income, output, consumer spending and retail sales before declaring official beginning and ending dates.
Regardless of the prospect of a downturn or whether it will meet the threshold of a recession, the consumer outlook over the next few months remains favorable, with most U.S. households continuing to have high levels of purchasing power. The economy is moving away from extremely strong growth toward moderate growth, but increased income from employment gains, rising wages and more hours worked is expected to support household spending. None of us can see around corners or say with any assurance what the future holds, but policy actions will likely be the deciding factor shaping the economic outlook this year and next.