By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast
As the consumer goes, so goes the economy! So far, the consumer continues to shop, travel, and visit food and drinking places. In fact, the consumer is buying so much that the surge in imports caused GDP growth to be negative during the first quarter.
The pandemic caused a deep decline in retail sales and consumer spending. This drop did not last long, however. In just a few months after the economic shutdowns of early 2020, U.S. retail sales climbed to record levels. Government stimulus provided support for additional spending, and households cleaned up their balance sheets by paying down debt and increasing the size of their checking accounts.
News for the consumer has been quite dismal. Gasoline prices are at historically high levels, now exceeding $4 a gallon. The equity markets have been quite volatile, erasing most of the gains from over the year. The S&P is teetering with bear market territory, about 20% down from the peak, and the NASDAQ is down around 30%. Forty-year high inflation and erosion of investment accounts show up in surveys of the consumer, such as the University of Michigan Survey of Consumer Sentiment. The latest survey showed a slight uptick in sentiment but remains at a level that last existed in the Great Recession. Sentiment levels are now lower than the deep pessimism that existed during the Covid shutdowns.
Consumers are telling surveys that their mood is quite sour, but their behavior is not consistent with survey results. As an example, the Census Bureau released the monthly retail sales report, and sales exceeded consensus estimates. A few takeaways show that food and drinking places were up by 2% and non-store retailers (i.e. Amazon and others) by 2.1%. Despite the lack of inventory, auto vehicle and parts dealers increased by 2.2%. Interestingly, gasoline stations were down by 2.7% from the previous month, representing the largest decline across all categories. Retail sales figures are not adjusted for inflation. So, even with historically high gas prices, sales were down by a significant level. This suggests that consumer behavior is changing around high gas prices, and households are finding ways to reduce and conserve.
The latest retail sales report tells us that despite all the doom and gloom, households continue to be quite resilient. This could change very quickly, thereby increasing the probability of a recession. One of the reasons why I don’t think we will see a recession this year is due to the consumer, both at the spending level and with the availability of jobs. Basically, we need to see more layoffs and a decline in consumer spending before we get to the point of increasing the probability of a recession. Unemployment claims are at historically low levels. The latest level of 218,000 is about the same prior to the pandemic and significantly under the 350,000 level that usually coincides with the start of a recession. Unlike the start of the Covid recession and the last Great Recession, we now have record job openings. In fact, the number of openings is about double the number of unemployed. Record openings and few layoffs are not consistent with the beginning of a recession.
With respect to consumer spending, we need to see spiraling declines in consumer spending, and that is simply not happening. While savings rates have come down, checkable deposits held by households remain at record levels. In other words, households still have lots of cash to spend. There is also unused debt capacity. That is, consumers can also borrow more. We are seeing some increases in consumer debt, but household debt ratios are still under the level that existed in February 2020, and well under Great Recession levels. Homeowners have seen burgeoning home equity levels but have yet to fully tap into it as a cash source. Home equity loans outstanding are at low levels, despite the record increases in home prices.
What about inflation? One part of the last CPI report that did not get much attention was the month-over-month price change. The last monthly increase tied for the smallest in the past 12 months. The monthly increase of .3% was significantly lower than the 1.2% monthly increase in March and tied with the .3% increase in August of last year. Last month may subsequently be viewed as peak inflation, and the CPI should begin to moderate as a result. Inflation expectations, as measured by the difference between 5-year Treasury Inflation-Protected Securities and 5-year Treasury securities, peaked in April, and have been on a steady decline since. Five-year inflation expectations are now under 3%. If I can “crystal ball” for a moment, as inflation numbers come in less than expected, equity markets should see a strong bounce.
To be sure, we will likely see a slowdown in the economy. We cannot continue growing at the rates observed last year. Even though consumers continue to spend, we will likely see a deceleration in goods spending, and an increase in services. A key metric that I will be following over the coming months is labor force growth. We were seeing nationwide gains earlier in the year, but last month saw no growth. State-wide, Indiana saw a noticeable increase last month, and Louisville Metro has been seeing some gains. For the national economy, labor force growth is critical. An expanding labor force will help boost supply and mitigate supply chain challenges. This will also provide stronger headwinds to inflation, along with the strengthening dollar.