US Weekly Economic Commentary: Shrinking goods sector

The latest data on industrial production suggest that the manufacturing sector might have entered recession late last year as consumer demand continued to shift away from goods and toward services.

Overall industrial production (IP) and manufacturing IP each fell sharply in both November and December, with the latter contracting at a 13.4% annual rate over those two months. Declines within manufacturing were widespread across both durables and nondurables sectors.

If we are correct in our projection that declines in manufacturing IP will continue over the first half of this year, then November will mark the start of recession in this sector.

At roughly the same time, there has been a notable weakening in consumer demand for goods as reflected in retail sales. Both total and non-automotive sales fell in November and December, with October and November levels revised down.

Weakness in the headline figures on nominal sales reflects more than declining prices for gasoline and other goods: We estimate that real retail sales fell in both November and December. Emerging weakness in goods sectors is occurring against the backdrop of a sharp contraction in residential construction and softness in business fixed investment.

Contractions in several sectors support our view that the US is already in or on the cusp of a recession. A recession is more likely than not to be mild and brief in part because of resilient demand within services as well as healthy household balance sheets and growth in labor income that will limit the extent of weakness in total consumer spending.

GDP growth estimate lowered

With last week's data, especially on retail sales, we lowered our estimate of fourth-quarter GDP growth by 0.4 percentage point to 2.4% and trimmed our forecast of first-quarter GDP growth by 0.2 percentage point to a 1.8% rate of decline.

Policymakers at the Federal Reserve, in recent appearances, stressed the need to remain committed to lowering inflation through a restrictive policy stance, including additional increases in the target for the federal funds rate.

It is all but assured that the Federal Open Market Committee (FOMC) will, as we have expected, hike the target funds rate by a quarter percentage point at the upcoming meeting that will conclude on Feb. 1. At least one more quarter-point rate hike is likely after February.

Our base forecast, consistent with our expectation for continued moderation in inflation, is that the FOMC will hike twice this year — in February and March, each by a quarter point — then pause to assess the cumulative impacts of tightening since March 2022. At that point, the upper end of the target range for the federal funds rate will have reached 5%, which we assume will be its peak for this cycle.

Policymakers, as a group, generally expect to hike the federal funds rate to a little above 5%, reflecting a more cautious outlook for progress on inflation. As priced into futures and interest-rate swaps, investors are relatively optimistic about falling inflation and project that the Fed will pivot to cutting interest rates in the second half of this year. A quick pivot to begin cutting interest rates is quite unlikely unless inflation falls more rapidly than we expect.

This week's economic releases:

• Conference Board's Leading Economic Index (Jan. 23): A decline in December would continue a trend and would be consistent with our view that the US economy is on the cusp of or already in recession.
• Manufacturers' new orders for durable goods (Jan. 26): We estimate that prices for durable manufactured goods, in the aggregate, have been essentially flat, leaving real durable goods orders in line with a modestly firming trend.
• Nominal goods deficit (Jan. 26): We estimate the deficit widened in December by $10.3 billion to $93.2 billion.
• New home sales (Jan. 26): We estimate new home sales declined in December to 595 thousand units compared with 640 thousand units in November. The level of new home sales remains low in a broader historical context.
• Nominal personal income (Jan. 27): We estimate nominal personal income rose 0.2%, while nominal personal consumption expenditures (PCE) fell 0.2% and real PCE declined 0.3%.
• Fourth-quarter real GDP advance estimate (Jan. 26): We estimate GDP grew 2.4% in the fourth quarter of 2022. This would suggest that GDP expanded at a healthy pace over the second half of last year.

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.