The queue for the Fifth Avenue Lego store snaked around the block one lunchtime this week, as New Yorkers and tourists jostled to pluck last-minute Christmas presents from shelves in the shadow of a plastic-brick model of the nearby Rockefeller Center.
The prime Manhattan shopping district is crowded again after two pandemic holiday seasons marked by health fears and supply shortages. At the end of a year in which the US has seen its highest inflation rates for four decades, the resilience of consumer spending has been one of the year’s economic surprises.
Despite rising prices for everything from groceries to gasoline, a doubling of mortgage rates and headlines warning of a possible recession in 2023, Americans are still spending freely — and providing an important underpinning for the economy.
The National Retail Federation expects this year’s US holiday retail sales to grow by 6-8 per cent over 2021’s record-setting $889bn. Some brands are pointing to a stronger season than that, with Nike saying on Wednesday that its North American revenues were up by double digits over Black Friday and Cyber Week.
Also this week, the Conference Board’s consumer confidence index reported its highest reading in eight months, buoying US stocks as investors asked whether it signalled that a recession might yet be dodged.
Such buoyant consumer demand is harder to find in Europe, where high energy costs and rising interest rates are contributing to a cost of living crisis that is particularly hitting many low-income households. Eurostat said this month that retail sales fell 1.8 per cent in October. However, many economists think the downturn in the European economy will be shallower than had initially been expected when Russia invaded Ukraine.
For policymakers in the US, the European experience raises the question of how long America’s shoppers can continue to defy the pessimists’ expectations. Is the strong Christmas spending simply delaying an inevitable slump?
Beyond the bustle in the top brands’ flagships, there are already signs that US shoppers are becoming more cautious and several of the factors that have kept them spending are starting to fall away.
The appetite for $850 Millennium Falcon Lego sets or the sequinned jumpsuits featured in the windows of Saks Fifth Avenue matters not just to the retailers on opposite sides of New York’s main shopping drag. There are few economic indicators that the Federal Reserve keeps a keener eye on than the health of the US consumer.
“It would be hard to watch anything much more closely than we watch consumer spending,” Jay Powell, the chair of the US central bank, told a press conference in June.
At a time when the central bank is actively trying to cool the economy in order to bring decades-high inflation under control, damping demand for various goods and services by rapidly lifting borrowing costs is central to its efforts.
Since March, the Fed has raised its benchmark policy rate from near zero to just under 4.5 per cent and it has signalled its intentions to take further action next year. Most officials now project that the federal funds rate will top out between 5 per cent and 5.25 per cent. Many, including Powell, have warned that they may need to go further should inflation prove more stubborn than they expect.
A winter of spending
Rise in US holiday retail sales expected this year, over the 2021 figure of $889bn — itself a record
Percentage wages have risen above their November 2021 level, according to the Atlanta Fed
‘Excess’ savings amassed by US households, thanks to Covid stimulus packages
Monetary policy adjustments take time to filter through the economy and start to change consumer behaviour, however. So far, the higher cost of borrowing has only marginally dented spending — reflecting a resilience that Mary Daly, president of the San Francisco Fed, said last week was “surprising”.
“People underestimated the resolve and the ability of the US consumer to spend throughout 2022,” says Michelle Meyer, chief US economist at the Mastercard Economics Institute. “That speaks to the sources of purchasing power that the consumer has enjoyed throughout 2022 and will continue to rely on in 2023.”
Americans have been flush with job opportunities for most of this year as companies scrambled to overcome crippling worker shortages, particularly in service sectors such as hospitality and travel. That has pushed up wages, which are now more than 6 per cent above their November 2021 level, according to the Atlanta Fed. The unemployment rate remains close to its pre-pandemic lows, at 3.7 per cent.
A big boost to US households’ purchasing power, though, has been the $2.2tn in “excess” savings that they amassed thanks to historic fiscal stimulus packages passed by US lawmakers to blunt the economic damage of the Covid crisis.
Economists at Citigroup reckon that Americans have now spent about $700bn of that sum. Many have also started to take on more borrowings: credit card debt, which plunged early in the pandemic as people with fewer options to spend paid down their balances, is now approaching pre-Covid levels. Even so, consumer debt levels as a share of disposable national income are still below 2019’s average.
“Households are entering 2023 with balance sheets at least as strong as pre-pandemic and by some metrics with more room to take on more debt,” Citi’s analysts wrote in a recent research note. “That should help support spending in the first half of 2023, even if real wage growth remains negative and job growth slows further.”
That is not what every retailer is banking on, however. Two blocks up Fifth Avenue from the Lego store, a Hollister clothing outlet was prominently pitching “holiday sale” bargains including $49 jackets and hoodies for $20. A $350 KitchenAid mixer, marked down by $100, was among the last-minute online bargains at Bed Bath & Beyond, the home goods chain whose sliding sales have left its bonds trading far below par.
“The headwinds of the past year are catching up to consumers and forcing them to be more conservative in their holiday shopping this winter,” Ellen Zentner, chief US economist for Morgan Stanley, wrote to clients last week. “While last year consumers rushed to buy gifts early due to low inventories, this year 70 per cent of consumers are waiting for discounts before starting their holiday shopping.”
Pent-up demand for meals out, entertainment and travel has shifted spending from goods to services as the pandemic has waned. Expensive purchases such as appliances, furniture and cars have been most affected, but now chains stocking more affordable items are reporting that their customers are chasing deals or trading down.
The Fed’s latest “Beige Book” collection of regional reserve banks’ anecdotal observations noted that inflation was driving shoppers, particularly those on low incomes, to “lower-priced items and lower-priced stores”. Hair salons were giving fewer haircuts, the Kansas City Fed found, even as high-end entertainment venues thrived.
Several consumer-facing companies tell a similar story, with Smith & Wesson complaining at this month’s earnings announcement that sales had been hit by consumers opting for cheaper guns. Church & Dwight has seen people trading down from $100 Waterpik flossers to $50 models, and from premium cat litter to its value brand. Dollar General, the discount chain, noted that more customers were choosing private label items or shopping closer to payday.
Such spending shifts are becoming evident around the world. A recent Mastercard study found that high food inflation was prompting consumers from Brazil to Indonesia to shop more often but spend less on each visit, hoping to avoid waste and manage their budgets.
Expected maximum federal funds rate next year, though Jay Powell has warned it may go higher under adverse conditions
Fed projections of the unemployment rate in 2023, as companies cut vacancies
Drop in spending during the average grocery shopping trip in the UK in 2022, though trips were more frequent. This pattern is expected to repeat in the US next year
In the UK, for example, consumers made 37 per cent more trips to grocery stores this September than in September 2019, but spent 10 per cent less per trip. “The reaction of the UK consumer is giving us a bit of a preview of what’s to come in 2023 in other regions, such as Australia, Canada and the US,” the report concluded.
For economists watching US consumers, the biggest wild card is how significantly the unemployment rate rises. People who feel that their jobs are at risk or that they will be unable to find new work may be less inclined to draw down savings or take on more debt, Meyer notes.
She contends that it may not take material job losses and a “collapse” in consumer spending for the Fed to feel able to back off its most aggressive campaign to tighten monetary policy since the 1980s. Rather, it will take a moderation in job growth and a softening of wage pressures, with unemployment rising to 4.7 per cent.
That aligns with recent projections from Fed officials, who maintain that the US economy can avoid a recession next year and see the jobless rate peaking at 4.6 per cent as companies favour cutting vacancies rather than pursuing mass lay-offs.
Other economists are less optimistic
James Knightley, chief international economist at ING, observes that chief executives’ confidence is at its lowest level since the global financial crisis. “If CEOs are this pessimistic then expect firms to move into cost-cutting [or] retrenchment mode,” he warns.
Coupled with a housing market where he thinks prices could fall by 20 per cent over the next 18 months as higher mortgage rates bite, “we have to be braced for a period where consumers are much more careful with their money”, Knightley argues. He thinks real consumer spending growth will start falling outright from about March to September next year.
Megan Greene, global chief economist at Kroll and an FT contributing editor, is expecting a recession around the middle of next year as the Fed pushes its policy rate above 5 per cent.
“The narrative that [companies] will just whittle down job openings and the labour market won’t deteriorate significantly is a really nice theory that doesn’t work so well in practice,” she says.
If employers do make deeper cuts, that may leave the Salvation Army bell ringers collecting for families in need this week entertaining thinner Fifth Avenue crowds next year.
As Greene notes: “Consumers tend to stop spending when they get laid off, their friends get laid off or they hear about lay-offs.”