U.S. Consumers Remain Resilient

Consumer spending is proving largely resilient in the face of high inflation and steep interest-rate hikes from the Federal Reserve that are dealing a sizable blow to housing and squelching manufacturing.

Retail sales—a measure of household spending that is the powerhouse of the nation’s economy —charged ahead in October with the biggest gain in eight months, according to Commerce Department data Wednesday. Meantime, more interest-rate–sensitive sectors, like housing and factory production, continued to show signs of weakness.

The sales figures show that the Fed’s inflation fight is far from over as it tries to restrict demand, but also indicates firm spending that risks keeping inflation elevated for longer. While many central bankers judge that it will soon be appropriate to slow the pace of tightening, their task is complicated by a steadfast consumer.

The Atlanta Fed’s GDPNow forecast for fourth-quarter growth moved up to 4.4 percent, from a previous estimate of 4 percent, after the stronger retail sales report.

“So long as people remain willing to run down excess savings in the face of higher borrowing costs and uncertainty over the economic outlook, consumption will stay reasonably strong into next year, partly offsetting weakness elsewhere and keeping the economy as a whole out of recession,” Kieran Clancy, senior U.S. economist at Pantheon Macroeconomics, said in a note. “But it will still be close.”

Not all economists are as sanguine. JPMorgan Chase & Co. joined most other Wall Street banks in forecasting a U.S. recession next year, though it expects the recession to be “mild.” The stronger-than-expected retail sales data potentially heightens the risk of a downturn if it’s met by even more punishing interest rates, according to Wells Fargo & Co. economists.

“It is tempting to cheer on the ‘resilience’ of the consumer, but the staying power of spending gives businesses no incentive to forgo price increases, thereby making the task of getting inflation in check more difficult for policymakers,” Wells Fargo’s Tim Quinlan and Shannon Seery said in a note.

Goldman Sachs Group Inc. economists on Wednesday added another Fed hike in May to their forecasts, due in part to what they see as “some risk that consumer spending could re-accelerate too much.”

The sales advance was broad-based, defying expectations that any strength would be a result of gains at auto dealers and gasoline stations. The retail figures aren’t adjusted for inflation.

However, it’s not clear whether household spending growth will be sustained into early 2023. The retail sales report showed the value of receipts at department stores and other discretionary categories, like electronics and sporting goods, fell, reinforcing earlier commentary from Target Corp. that shoppers are “increasingly impacted by inflation, rising interest rates, and economic uncertainty.”

Another potentially troubling issue with the current spate of consumer spending is that it’s being supported by borrowing and depleting savings. In the third quarter, U.S. household debt climbed at the fastest annual pace since 2008, with credit-card balances surging, according to data released by the New York Fed on Tuesday.

Also bolstering consumers is a tight labor market, marked by robust job creation, low unemployment, and rising wages. Fed Chair Jerome Powell said earlier this month that supply and demand for jobs remains out of balance and that conditions haven’t softened yet in an “obvious” way.

The Fed’s tightening so far—nearly four percentage points in the past eight months—has mainly had an impact on smaller sectors of the economy. Separate data Wednesday showed homebuilder sentiment fell again amid a steep climb in mortgage rates, and factory output barely rose in October.

While inflation is showing signs of moderating—consumer and producer price growth both slowed by more than forecast last month—it’s still too soon to declare that the Fed has won the fight against price pressures. San Francisco Fed President Mary Daly said Wednesday that the consumer is “hanging in there” and a pause in hiking rates is “off the table right now.”

“I think it is far too soon to expect a persistent and rapid downshift in inflation, and the answer to that question is far more important than economic growth prospects, but they all tie together,” Stephen Stanley, chief economist at Amherst Pierpont Securities, said in a note.

“If the economy muddles through rather than falling into recession, then the labor market is likely to remain strong for a while longer and, most importantly, inflation will probably remain elevated for now.”

—With assistance from Augusta Saraiva.

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