March Economic Data Points To A Loss Of Momentum

Scott Anderson
Chief Economist
Bank of the West

The Fed interest rate hikes, loss of pandemic assistance, and high prices are finally starting to take a toll on the U.S. consumer. Total nominal retail sales fell 1.0% in March following a 0.2% decrease in February. This was double the consensus forecast of -0.5% and down sharply from the 3.1% surge in retail sales in January that was largely driven by a social security cost-of-living adjustment of 8.7% – the largest since 1981. The social security payment increase helped bolster real disposable personal income by an 18.6% annualized pace in January.

Notwithstanding the strong income gain to start the year, retail sales declined in eight of the 13 categories last month with the largest decreases coming from discretionary and interest rate sensitive categories such as building material stores (-2.1%), electronic stores (-2.1%), clothing stores (-1.7%), motor vehicles and parts (-1.6%) and furniture stores (-1.2%).

Sales Declines Were Broad-Based In March

However, spending at bars and restaurants – the only services category in the retail sales report managed a modest 0.1% increase following a 1.6% decline in February. The largest sales increases were in nonstore retailers (+1.9%), health stores (+0.3%) and sporting goods stores (+0.2%) last month.

Retail sales from a year ago slipped to a 2.9% growth rate down sharply from 5.9% in February and the weakest annual advance since June 2020. It is becoming increasingly apparent that U.S. consumers are preparing for economic conditions to deteriorate over the near term and are becoming more selective in their spending.

Retail Sales Growth From A Year Ago Turns Sluggish

As consumer and business demand weakens we continue to see downward pressure on U.S. manufacturing production. Although total industrial production climbed 0.4% in March – double the consensus projection and up from 0.2% in February – it was entirely due to an 8.4% surge in utilities output as seasonal temperatures fluctuated wildly.

Manufacturing production – which is nearly 75% of total industrial production – fell 0.5% on declines of 1.5%, 0.8% and 0.7% respectively in the production of motor vehicle and parts, computers and electronics and machinery. Business equipment production plunged 1.0% as information processing production dropped 1.3% and construction supply production fell 1.8%. Production cut backs in information processing and construction supply may be an important indication that the business investment outlook darkened noticeably last month. The third monthly decline in U.S. manufacturing production in the last five months pushed total U.S. manufacturing production down 0.9% from a year ago.

U.S. Manufacturing Production Is Contracting Again

Consumer sentiment data for April released today could signal a more cautious consumer in the months ahead. Consumers now expect prices to increase 4.6% over the next 12 months, up from 3.6% in March and the biggest monthly jump in nearly two years. OPEC+'s decision to cut oil output by more than a million barrels a day is leading to another round of price increases at the gas pump. The expectation of higher price inflation could continue to prompt consumers to bolster their savings and limit spending as they feel less secure about their finances.

Consumer Spending and Interest Rate Outlook
The resilient U.S. consumer is showing increasing strains due to elevated inflation and dwindling savings, aggressive interest rate hikes by the Fed, slowing job gains and the increasing probability of a U.S. recession ahead as financial conditions tighten further. Real consumer spending is forecast to decline in the second and third quarters of this year after increasing at a strong 4.5% annualized in the first quarter on the back of January's blowout income and spending binge.

Real Consumer Spending To Decline For Two Quarters

We believe a shallow recession is still on the horizon despite the deceptively strong Q1 performance. The Fed is expected to raise interest rates by another 25 basis points in May, bringing the terminal fed funds rate above 5.0%, as their inflation fight continues. After that, the Fed is expected to pause for the remainder of 2023 to assess the impact of rate increases on the real economy before beginning to cut interest rates around the first quarter of next year to support the economic recovery. At that point, core consumer inflation will be gliding towards the Fed's medium-term target of 2.0%, empowering the FOMC to resume focusing on its dual mandate of full employment and stable inflation. The Fed will ultimately squelch stubbornly-high inflation but the cost will likely be job losses, higher unemployment, and a mild recession before the end of the year.

To learn more, check out this week's U.S. Outlook Report.


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