U.S. Economy Losing Momentum As Retail Sales Post Largest Plunge In 12 Months

Summary

• Retail sales drop 1.1% in December; November sales lowered
• Core retail sales fall 0.7%; November sales unrevised
• Manufacturing production declines 1.3%; November output cut
• Producer prices drop 0.5%; up 6.2% year-on-year

U.S. retail sales dropped by the most in a year in December, knocked down by decreases in purchases of motor vehicles and a range of other goods, placing consumer spending and the overall economy on a weaker growth path going into 2023.

The second successive monthly decline in retail sales, which are mostly goods, is weakening production at factories. Manufacturing output registered its largest drop in almost two years in December, while monthly producer prices also fell, separate data showed on Wednesday.

The widespread signs of softening demand and easing inflation are likely to encourage the Federal Reserve to further reduce the pace of its rate hikes in February, but not halt its monetary policy tightening anytime soon as the labor market remains tight. The U.S. central bank has embarked on its fastest rate-rising cycle since the 1980s.

“Consumers are likely retrenching during a time of economic uncertainty,” said Jeffrey Roach, chief economist at LPL Financial in Charlotte, North Carolina. “The trajectory for the economy is weakening and recession risks are rising for 2023.”

Retail sales plunged 1.1% in December, the largest fall since December 2021. Data for November was reviewed to show sales declining 1.0% instead of 0.6% as previously reported. Economists surveyed by Reuters had predicted sales falling 0.8%. Retail sales jumped 6.0% year-on-year in December.

Retail sales are not adjusted for inflation. Last month’s fall in sales was likely in part the result of goods prices plunging during the month. Holiday shopping was also propelled forward into October as inflation-weary consumers made the most of discounts offered by retailers.

A cold snap in December likely weakened sales at bars and restaurants. Lower gasoline prices, which affected receipts at service stations, also helped to pull down sales. In addition, spending is moving back to services.

The model that the government uses to remove seasonal fluctuations from the data has not completely adjusted for the shift to more front-loaded holiday shopping since the onset of the pandemic, economists at Bank of America said.

Even accounting for the distortions, rising interest rates have increased the cost of credit, which many Americans use to pay for goods purchases, destroying retail sales in recent months.

The Fed’s Beige Book report on Wednesday illustrated consumer spending as rising “slightly, with some retailers reporting more robust sales over the holidays.” But it added, “retailers noted that high inflation continued to reduce consumers’ purchasing power, particularly among low- and moderate-income households.”

Sales at auto dealers plummeted by 1.2%. Receipts at service stations fell 4.6%. Online retail sales fell 1.1%. Furniture stores sales dropped 2.5%. Receipts at food services and drinking places, the only services category in the retail sales report, tumbled 0.9%.

Electronics and appliance store sales dropped 1.1%. There were also declines in clothing stores sales together with receipts at general merchandise stores. But sporting goods, hobby, and musical instrument stores expanded on gains as did garden equipment and building material suppliers.

The Fed in 2022 lifted its policy rate by 425 basis points from near zero to a 4.25%-4.50% range, the highest since late 2007. Last month, it predicted at least an additional 75 basis points of rises in borrowing costs by the end of this year.

Financial markets have priced in a 25-basis point rate hike at the Fed’s Jan. 31-Feb. 1 meeting, according to CME’s FedWatch Tool. Stocks on Wall Street tumbled. The dollar was strong against a basket of currencies. U.S. Treasury prices surged.

Manufacturing Output Drops

Excluding gasoline, automobiles, food services, and building materials, retail sales declined 0.7% in December. These so-called core retail sales fell by an unrevised 0.2% in November.

Core retail sales correlate very closely with the consumer spending component of gross domestic product. The weakness in core retail sales is likely to be compensated for by expected gains in services spending. Consumer spending continues to be shored up by labor market tightness, which is keeping wages raised.

The jobless rate is at a more than the five-decade low of 3.5%.

“Consumers have shifted spending more toward services as they return closer to a pre-pandemic ‘normal’ of traveling, dining out, and attending live events,” said Will Compernolle, a senior economist at FHN Financial in New York.

With inflation-adjusted consumer spending rising 0.5% in October and staying unchanged in the next month, economists hold growth in overall consumer spending in the December quarter would surpass the 2.3% annualized rate recorded in the third quarter.

Gross domestic product growth estimates for the fourth quarter are as high as a 3.5% rate, also representing the largest contraction in the trade deficit in November since early 2009. The economy expanded at a 3.2% rate in the third quarter. However, the economy went into 2023 with less momentum. Wage growth is declining and savings are also falling.

Another report from the Fed showed manufacturing output slipped 1.3% last month, the biggest decline since February 2021, and production in November was much weaker than initially anticipated.

Most economists forecast the economy will fall into recession by the second half of 2023, though there is cautious optimism that moderating inflation could deter the Fed from lifting its target rate above the 5.1% peak it projected in December.

This would lead to growth only weakening sharply rather than the economy shrinking. Inflation continues to subside, with a third report from the Labor Department showing the producer price index for final demand fell 0.5% last month after rising 0.2% the prior month.

The government disclosed last week that monthly consumer prices declined for the first time in more than 2-1/2 years in December.

José Torres, senior economist at Interactive Brokers in Miami, said:

“The Fed is making progress in fighting inflation and while it’s unclear if it will cause the Fed to become more dovish, it at least implies that the central bank may not need to become more aggressive in raising rates and tightening liquidity.”