NRF economist says full effect of Federal Reserve’s monetary tightening has not shown up

National Retail Federation Chief Economist Jack Kleinhenz today said NRF’s 2023 retail sales forecast was one of the most difficult he has ever prepared.

“The broad economic environment in the United States today is anything but normal,” Kleinhenz said, noting that unemployment is near historic lows and consumers have excess savings even though interest rates are increasing rapidly and both the banking and financial markets are unsettled. “In all my years of forecasting, it has never been so challenging to put together the pieces of the economic puzzle and connect them to where the economy is heading. And the disruption and uncertainty are likely to persist.”

“The year ahead will be a bumpy journey,” Kleinhenz said. “Consumer confidence, especially with banks, needs to be maintained in order to sustain spending in these uncertain times. The wildcard is what the Fed will do with interest rates in the coming months.”

Kleinhenz’s remarks came in the April issue of NRF’s Monthly Economic Review, which detailed the reasoning behind NRF’s forecast that 2023 retail sales will grow between 4% and 6% over 2022 for a total of between $5.13 trillion and $5.23 trillion. That would be slower than 2022’s 7% growth but still above the pre-pandemic average of 3.6%. The numbers exclude automobile dealers, gasoline stations and restaurants to focus on core retail.

With the Federal Reserve continuing to increase interest rates to fight inflation, Kleinhenz doesn’t expect a recession but said the forecast assumes gross domestic product growth will slow from nearly 3% in the second half of 2022 to 1% in 2023. The forecast also assumes the U.S. banking system is “sound and resilient” as stated by the Fed, with no additional incidents like the collapse of Silicon Valley Bank to cloud consumer confidence.

The five percentage point increase in interest rates imposed by the Fed over the past year is one of the most rapid ever seen and has had an impact on inflation, but hasn’t slowed the economy as much as expected, Kleinhenz said. Housing, trade and business investment have been affected, but “consumers have had uncanny staying power” supported by continued job and wage growth, a stockpile of savings built up during the pandemic, access to credit, and lower energy costs. Combined January-February retail sales grew 6.6% year over year and the economy likely expanded during the first quarter despite higher borrowing costs.

Strong labor and economic activity is maintaining upward pressure on inflation, but the numbers are falling. The Personal Consumption Expenditures Index – the Fed’s preferred measure of inflation – was up 5% year over year in February but that compared with 5.3% in the previous two months and a peak of 7% last June. Kleinhenz expects inflation will average between 3% and 5% during 2023.

With pandemic lockdowns long gone and consumers comfortable venturing outside the home again, inflation will be higher for services ranging from restaurant meals to airline travel than for retail merchandise. That has already been reflected in the PCE index for services, which increased from 5.6% in January to 5.7% in February while the PCE index for goods declined from 4.7% to 3.6% for the same period.

Even so, inflation is difficult to measure and more difficult to forecast, Kleinhenz said.

“I don’t believe the full effect of tightening has shown up,” he said. “Monetary policy works with long and variable legs, and it’s too early to know the true effect of interest rates on the base of the economy.”