US Weekly Economic Commentary: Resilient consumers

Consumer spending is resilient despite headwinds from waning fiscal support, reductions in net worth this year, higher interest rates, and erosion of real incomes and wealth from price increases.

Total nominal retail sales rose 1.3% in October, well above expectations. After adjusting for price changes, we estimate that real retail sales rose approximately 1% in October. Furthermore, past levels of retail sales were revised up.

Largely on the resiliency in retail sales, we revised up our forecast of fourth-quarter GDP growth by 0.7 percentage point to +0.4%. Still, we continue to expect a period of weakness prompted by tighter financial conditions that is likely to tip the US into a mild recession.

Several factors suggest the recession will be mild, including ongoing improvement in supply chains that will support increases in production in the vehicle sector, the absence of large-scale inventory overhangs that would be unwound quickly and weigh on production, and the accumulated savings of households reinforced by past increases in household wealth that will limit the slowdown in real consumer spending.

In our most recent base forecast, we predicted a peak-to-trough decline in real GDP through the second quarter of 2023 of just 0.7%, which would be one of the mildest recessions in recent decades.

Financial conditions have eased of late. Some of that easing could prove to be temporary because it is at odds with the Fed's intent of using interest rate, balance-sheet, and communication policies to support restrictive financial conditions that will weaken demand and, it intends, support a reduction of inflation to its 2% target over the next two to three years.

The Fed's next move

To the extent that market developments — recent increases in broad equity values, the latest downturn in private borrowing costs, and some backing down in the trade-weighted value of the dollar — reflect an easing of broad financial conditions, the Fed might have to push harder with its policy tools to generate a degree of financial tightening it expects will be sufficient to put inflation on a downward trajectory.

The Fed has signaled that it expects as soon as December to slow the pace of rate hikes, but it is concerned that this message is being interpreted as suggesting that it will not maintain a sufficiently restrictive stance for as long as needed to lower inflation. Communication from Chair Powell is focused more on the peak range for the federal funds rate than on the exact sequence of rate hikes from this point forward.

Similar considerations led Fed Governor Waller to emphasize the need to act forcefully to minimize the risk of a rise in long-term inflation expectations. St. Louis Fed President Bullard cautioned on Thursday that the Fed could push its policy rate considerably higher than currently priced into bond markets (perhaps to as high as 7%), depending of course on the trajectory for inflation.

We expect the Federal Open Market Committee will moderate the pace of rate hikes beginning next month with a half-point rate hike, likely followed by quarter-point increases in February and March. These moves would bring the upper end of the target range for the federal funds rate to 5%, where we expect it to remain throughout the rest of 2023 and into the first part of 2024.

Barring a much faster decline of inflation, we think it highly unlikely that the Fed would "pivot" and start cutting rates in the second half of 2023 as priced into futures and interest-rate swaps and as suggested by the latest downturn in Treasury yields.

This week's economic releases:

• Manufacturers' orders for durable goods (Nov. 23): We estimate that prices for manufactured durable goods eased a bit in October. Real orders for durable goods remain broadly in line with what has been a flat trend since early 2021.
• New home sales (Nov. 23): We estimate 585 thousand units for October, down from 603 thousand units in September. Elevated mortgage rates and home prices have weighed on affordability and housing activity.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.