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Bottom line the Fed’s policies are working and the economy is slowing

January 18, 2023

Retail sales, a measure of purchases at stores, restaurants and online, declined a seasonally adjusted 1.1% in December from the prior month, the Commerce Department said Wednesday. That was the biggest monthly decline in a year and marked the second consecutive month of falling sales. November retail sales were revised lower, to a 1% decline, marking a soft close to the holiday shopping season.

The decline in retail spending late last year adds to signs that the U.S. economy is slowing. Hiring and wage growth eased in December, U.S. commerce with the rest of the world declined significantly in November, and existing-home sales have fallen for 10 straight months.  

The economy is cooling as the Federal Reserve pushes up interet rates to combat inflation. Economists surveyed by The Wall Street Journal this month expect higher interest rates to tip the U.S. economy into a recession in the coming year.

“The lag impact of elevated inflation weighs heavily on U.S. households, it’s very clear that the median American consumer is still reeling from the loss of wages in inflation-adjusted terms,” said Joseph Brusuelas, chief economist at RSM US LLP. “We’re moving towards what I would expect to be a mild recession in 2023,” he added.

I have been sharing that the main reason for the downturn in the markets last year was the pressure that the Fed put on economy through interest rate increases. Those increases discourage borrowing and are meant to cool the economy so that prices stop rising (inflation).

Inflation, while still historically high, is showing signs of cooling as demand eases. Consumer prices advanced at a slower annual rate in December for the sixth straight month. The producer-price index, which generally reflects supply conditions in the economy, fell in December from the prior month, and increased at the slowest annual pace since March 2021, the Labor Department said Wednesday.

Separately, the Fed said Wednesday that industrial production slumped a seasonally adjusted 0.7% in December, led by weakness in the manufacturing industry.

While December is an important month for the holiday shopping season, some retailers discounted heavily and early to clear excess stock from their shelves and warehouses, which analysts said pulled gift shopping into October.

It was reported that dining out at bars and restaurants dropped 0.9% on the month, in December. Sales of furniture and vehicles, which are sensitive to higher borrowing costs, both fell sharply. The only categories to post slight growth in December were home improvement, grocery and sporting goods stores. Does this reflect your buying habits for the past two months?

Some retailers have said the recently completed holiday shopping season turned out to be weaker than expected. Macy's Inc. warned of softer sales, and Lululemon Athletica Inc. said its profit margins were squeezed as shoppers bought more items on sale. In 2021, officials thought high inflation would be temporary. But a year later, it was still near a four-decade high. WSJ’s Jon Hilsenrath explains factors that have kept inflation up longer than expected. 

Other large retailers are struggling. Party City Holdco Inc. filed for chapter 11 bankruptcy while noting inflationary pressures have hampered customers’ willingness to spend. Bed Bath & Beyond Inc. said this month it plans more layoffs and cost cuts amid falling sales.

Unlike many government reports, retail sales aren’t adjusted for inflation and can reflect price differences in addition to purchase totals. From a year earlier, overall retail sales advanced 6%, a slightly smaller gain than the 6.5% increase in consumer prices.

“Consumers are pulling back a little to get more for their dollar,” said Andrew Hogenson, a consumer expert at Infosys Consulting. He expects that the recent rise in Covid cases has made some Americans more cautious about dining out at bars and restaurants this winter.

The retail sales report offers a partial picture of consumer demand because it doesn’t include spending on many services such as travel, housing and utilities. The Commerce Department will release December household spending figures covering goods and services later this month.

Corporate reports out in February will add to that picture. Walmart Inc., Target Corp. and other large retailers that sell a variety of goods such as food, clothes and décor, report quarterly earnings next month, which will include December sales.

Bottom line the Fed’s policies are working and the economy is slowing. When the Fed stops raising interest rates which I suspect will be within the next three months we will be facing a new pressure on stocks: earnings. Initially this will show a slowdown and reduced profits. But as corporations adjust their costs by layoffs and cutting debt, they will become highly productive. As a result they will not need the sales of past to secure the same profits. I suspect we will begin to see the results of those cuts and increased productivity by the second half of this year.

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