Weak Economic Data Heightens U.S. Recession Risks

Scott Anderson
Chief Economist
Bank of the West

Weak Economic Data Heightens U.S. Recession Risks
While the Fed seems to be gaining the upper hand on the inflation battle – the latest evidence being a 0.5% monthon-month decrease in producer prices in December– the casualty increasingly appears to be slowing U.S. economic growth based on weaker than expected December retail sales and manufacturing production data released earlier this week.

Retail sales decreased 1.1% in December after a downwardly revised decline of 1.0% in November. This was below the consensus forecast of -0.9% and the largest monthly drop since December 2021. Retail sales haven’t declined for two consecutive months since December of 2020, pointing to a sustained pullback in consumer demand in the latter half of the holiday season as the combination of two years of high inflation, a year of slumping equity markets, and rising U.S. recession fears take their toll.

Some of the weakness in the December report can be attributed to a rotation in consumer spending away from goods and toward services. The retail sales report mainly captures spending on goods with the exception of restaurant spending. Sales declines were fairly broadbased across sectors with some of the largest declines in discretionary spending categories like furniture stores (- 2.5%), motor vehicles and parts (-1.2%) and electronic stores (-1.1%). Even receipts at restaurants and bars declined 0.9% following a 0.1% drop in November, suggesting consumers might be starting to shy away from paying sky-high food and drink prices.

Retail sales growth over the last year is still a solid 6.0%, but gains have steadily diminished since July’s double-digit increase of 10.0%. Over the past year, sales gains have been the strongest for nonstore retailers (+13.7%), restaurants and bars (+12.1%) and grocery stores (+6.9%). The only category where retail sales declined from a year ago was electronics stores (-5.6%).

Retail Sales Gains From A Year Ago Are Still Pervasive
Recent data on U.S. manufacturing activity has been just as alarming. Manufacturing production fell 1.3% in December, significantly below the consensus forecast of - 0.2% and the largest monthly drop since February 2021. Moreover, this is the second straight monthly decline, suggesting the cyclical and interest-sensitive manufacturing sector is getting hammered by aggressive interest rate hikes by the Fed, a strong dollar and slowing overseas economies. For the fourth quarter, industrial production fell an annualized 1.7%, the sharpest quarterly decline since COVID lockdowns closed manufacturing facilities.

Manufacturing Production Dropped Last Two Months
There is some encouraging news for goods price inflation buried in the December industrial production report. Capacity utilization dropped to 78.8% from 79.4% in November. This is the third consecutive monthly drop in capacity utilization and the lowest since December 2021, pointing to sharply easing supply constraints in the U.S. manufacturing sector. Manufacturing and mining capacity utilization fell 1.0% and 0.9% respectively, while utilities capacity utilization rose 2.7%.

U.S. Economic Outlook
The U.S. economy lost considerable momentum late last year that is likely to persist in early 2023, particularly with the Fed expected to continue to raise interest rates by another 75 basis points by May. A mild U.S. recession in the first half of 2023 remains our baseline forecast with real GDP contracting for two quarters in a row before gradually rebounding in the second half of the year.

U.S. Real GDP Projected to Decline 1H2023
The contraction in economic activity will largely be driven by aggressive monetary policy tightening by the Fed and a cooling labor market that will push the unemployment rate up to just shy of 5.0% in the first quarter of 2024 with the Fed ultimately achieving its stated goal of lowering runaway inflation back toward The Fed’s target by 2024.

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


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