Monthly Economic Review: July 2023

Economy has more momentum than most thought but has started to slow
August 2023 Monthly Economic Review

The year is half over and the economy is still moving in the right direction. While its rhythm, tone and pattern have slowed, it has not stalled, and recently revised data shows underlying strength that seems to be rolling forward.

There was clearly better momentum in the first half of 2023 than was recognized at first. Based on more complete data now available, the Bureau of Economic Analysis says first-quarter gross domestic product grew at an annual rate of 2% adjusted for inflation rather than the 1.1% originally reported. The upward revision was driven in part by stronger consumer spending, which accounts for 70% of U.S. GDP and grew at a 4.2% annual rate despite the strong headwinds of high interest rates and elevated inflation. That was the fastest growth since mid-2021 and far better than the fourth quarter’s 1%. Revisions also lifted the personal saving rate from 3.4% to 4.3% and other details were stronger, too. Private final sales to domestic purchasers – which exclude inventories and imports and are a good indicator of underlying growth – were revised up to a sturdy 3.2% from the 2.9% previously reported. That was far faster than the zero growth in the fourth quarter.

While first-quarter consumer spending was decent, it decelerated in May, signaling that a slowdown can be expected when second-quarter results are released. Household spending rose a mere 0.1% compared with 0.6% in April. After adjusting for inflation, “real” consumption was unchanged in May and remained up 2.1% from a year ago. Spending continues to shift slowly from goods, which declined 0.5% in May, to services, which increased 0.4%. Retail sales, which make up nearly 40% of consumer spending, grew across most retail categories, due in part to strong job and wages gains resulting from the tight labor market, but at a slower pace. NRF’s calculation of retail sales – which excludes automobile dealers, gasoline stations and restaurants to focus on core retail – was up 0.4% month over month compared with 0.6% growth in April.

During June’s meeting, the Federal Reserve’s Open Market Committee debated interest rate hikes but left rates unchanged for the first time in 10 months. No one knows how long it will take for the effect of already-done rate increases and credit tightening to ripple through the economy, and the committee said the pause will let members “assess additional information and its implications.” Forecasting inflation is difficult and few have gotten it right, so a pause is a prudent move.

The cycle of hiking rates is likely not done, however. Each member of the committee was asked to indicate where they believe the federal funds rate should be in the future, and the answers showed a wide dispersion. Four see one more increase, nine expect two, two expect three more hikes and one saw four more. Two members do not envision hikes this year. While just projections, the members’ forecasts often signal the committee’s direction, and the divergent answers cast uncertainty on how extensive rate hikes might be this year.

Recent reports have shown that the labor market remains rather resilient even as inflation levels decline. Employers added 339,000 jobs in May, according to the Bureau of Labor Statistics. However, the unemployment rate rose by three-tenths of a percentage point to 3.7%. That was the biggest one-month increase since the rate surged in April 2020 and the highest unemployment rate since last October.

Meanwhile, inflation remains elevated but is slowing and taking pressure off the American household. The Federal’s preferred measure of inflation, the Personal Consumption Expenditures Price Index, was up 3.8% year over year in May, the first time it had been below 4% since early 2021 and a considerable improvement both from April’s 4.3% and the peak of almost 7% in mid-2022. Core services, including housing prices, have been the primary driver of inflation in 2023 and remained stubbornly high at 5.3%.

Looking forward, the resiliency of the U.S. consumer will be tested in the coming months as headwinds from higher interest rates signaled by the Fed, tighter credit conditions and the resumption of student loan payments are likely to impair spending. Nonetheless, households have approximately $500 billion in excess savings built up during the pandemic that should continue to support spending for most of the remainder of 2023. While the state of the U.S. economy is a bit murky, consumers are currently the path of least resistance to economic growth and are doing their part to keep the economy moving ahead. The economy is still healthy and as long as employment growth holds up, consumers will still be willing to spend. The flip side of resilience, however, is that the Fed might need to raise rates further to push inflation down toward its target of 2%.

Past issues

Monthly Economic Review: June 2024
Year Ahead Depends on Jobs, Inflation and the Fed.
Read more
Consumers Remain ‘Willing to Spend’
Shoppers remain willing to buy even as smaller job and wage gains and high interest rates slow spending growth.
Read more
Monthly Economic Review: May 2024
First quarter results show economy slowing but still growing.
Read more