Recession worries remain in 2023, but spotlight shifts to the Fed

The Fed must strike a "delicate balance" between inflation and interest rates. Check out 5 tips for brand leaders walking the economic tightrope.

Recession worries remain in 2023, but spotlight shifts to the Fed

As 2023 dawns, the big question for the economy remains the same as the second half of 2022: Will there be a recession However, the framing of the two interconnected forces that will determine the answer has shifted.

Inflation is coming down, but the Federal Reserve will continue to raise interest rates until it stays down. But interest rates also cool the economy, so its actions are also likely to draw more attention if evidence of slowing consumer demand begins to emerge.

“It isn’t impossible to sidestep a recession, but when the economy slows it becomes very fragile and the risk rises significantly,” National Retail Federation Chief Economist Jack Kleinhenz wrote in a monthly review. “If a recession is in the cards, it will likely be rising interest rates that set it off.”

In a time of economic swings, the Fed's campaign to lower inflation brought the latest about-face. After starting the year at zero, they ended at the highest level since 2007.

Late last year, there were signs that these efforts were making progress. The growth of PCE inflation, which is the Fed’s preferred price gauge, cooled down in the most recent reading for November. The Consumer Price Index, which is the most widely-viewed inflation measure, equally showed a broad-based cooldown of price gains in gas and some consumer goods categories.

Consumer Price Index, Dec. 2021-Nov. 2022. (via FRED/St. Louis Fed)

But the 5.5% PCE inflation was still well above the Fed’s 2% goal, and central bank officials said there will be more interest rate hikes coming in 2023. They don't want to repeat the mistakes of the 1970s, when officials ended their campaign too quickly, causing even more economic pain and higher rates.

While history is the guide, the result in the present could be cooling consumer demand. In November, the PCE report showed that consumer spending grew just 0.1% for the month, down from 0.9% growth in October. US retail sales for the month also registered a 16-month low for the month.

But the bottom hasn’t fallen out yet. The job market, which is a key predictor of consumer activity, continues to roar. Black Friday deals drove records at retailers like Nike and Lululemon, while Mastercard SpendingPulse data showed that ecommerce grew more than 10% over 2021 during the holiday season.

Inflation will continue to be a concern. After all, in the face of high prices, retailers like Walmart and Kroger have been reporting shifts in consumer behavior toward smaller goods, store brands and discount-driven shopping for months.

“When we talk to our customers, they are telling us they are changing,” Kroger CEO Rodney McMullen recently told analysts. “But so far, they are changing on purchases other than food.”

When it comes to the economic picture as a whole, the impacts of the latest actions are more difficult to see on the ground. Interest rates take months to wind their way through the economy. Results are delayed, and they are unlikely to arrive at the same time.

It will mean another year of parsing every data point for hints about what is happening, and gaming out potential cause-and-effect reactions. One predictor of the so-called “soft landing” would be to see inflation coming down before the job market cools, Kleinhenz wrote. But there is no exact formula to bring this about. The Fed is trying to steer the ship, rather than pressing buttons. Its main goal is to bring down inflation, and will want to see evidence that is happening before it lets up. Job growth may pay a price in the meantime.

“The danger is that if the Fed overestimates the strength of the consumer and tightens too aggressively, the spending that has kept the economy growing could crater, resulting in a hard landing instead,” Kleinhenz wrote. “There are downside risks both to doing too much and too little, and the Fed is well aware that the balance is delicate.”

For brands and retailers watching this play out and trying to determine how to respond, this can be a nervy time. Here are a few tips to remember to keep things in perspective:

One month's data is not a trend. One month of data is just one month. Seek insights that are actionable, but look to longer timelines for the full story.

Talk to customers often. When data is murky, their words and behavior say a lot.

Prepare for multiple scenarios. We may enter a recession, and we may not. Have a plan for both cases, and others along the way.

Control what you can control. It's easy to blame the Fed, but you're not going to change what it does anymore than you can bring down inflation, unclog supply chains or stop a pandemic. Make decisions based on your context, and your team.

Everyone is going through this. Have a network? This is the time call on it.

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