How Bad of a Recession? It Depends on the Consumer

Commentary

Consumer spending drives two-thirds of the U.S. economy. But the resolve of American consumers will be put to the test.

The stock market, tugged by fears of high interest rates, has gyrated most of the year. Year-over-year inflation has risen to heights not seen in more than 40 years. The bottom is threatening to fall out of home prices. As for jobs? Headline numbers remain strong, but layoff announcements are piling up, and many companies have instituted hiring freezes.

Official gross domestic product numbers declined in the second quarter, pushing the U.S. economy into a technical recession. While economists and politicians argue over the semantics of what defines a recession, such arguments would quickly be rendered moot if American consumers were to decide to materially tighten their purse strings.

Experts at Goldman Sachs agree. During an August webinar, for example, Goldman economists believe, for now, that consumers overall are in good shape.

“They are coming into the current downturn with good balance sheets,” Goldman’s Richard Ramsden said in the webinar.

But sentiment could change if job losses mount, causing credit conditions to deteriorate such as the defaulting of loans.

The job market is indeed the wild card. If Americans remain employed, given the largely healthy balance sheets and home equity, consumers can keep spending at levels that will allow most sectors to ride out a recession.

The numbers show a mixed bag of results so far. Official unemployment rates are down to 3.5 percent, though the labor participation rate is quite low and getting lower, at 62.1 percent. While job gains are still quite high (July added 528,000 jobs, for example), companies have announced massive layoffs and instituted hiring freezes.

Consulting firm PricewaterhouseCoopers found that 50 percent of the companies it surveyed in August anticipated a net reduction in employee count, while 52 percent said they would implement hiring freezes, and 44 percent said they had rescinded job offers. Anecdotally, companies in the technology sector have announced the most layoffs.

Wages and income are other critical variables. Economists have found that lower-income workers have experienced more wage gains than their higher-income counterparts. But none of the gains could keep up with uncomfortably high inflation—which sat at 8.5 percent in July—taking a dent out of real wages.

In some ways, it’s a Catch-22: If consumers lose their jobs and wages, they can’t spend money to prop up the economy. When that happens, businesses will cut budgets and lay off workers, creating a self-fulfilling downward spiral that exacerbates this cycle.

The Federal Reserve has signaled that it’s committed to raising and keeping interest rates high enough to drive down inflation, even at the expense of the U.S. economy. Federal Reserve Chair Jerome Powell said, at the bank’s annual late-August meetings in Jackson Hole, Wyoming, that the Fed’s “forceful” actions may “cause some pain” to the economy.

The Fed believes that combating inflation—which hurts Main Street consumers in their day-to-day activities—is potentially more important than appeasing the stock market and the real estate market, or lowering borrowing rates for corporations and individuals.

Retailers Already Feeling the Impact

Retail companies are at the forefront of this discussion. The retail sector employs 15.8 million workers as of July, one of the nation’s biggest employment sources. But retail is also very susceptible to economic trends.

“If we’ve learned anything from previous recessions, it’s that they expose existing weaknesses, accelerate emerging trends, and force organizations to make structural changes,” consulting firm Deloitte said in a recent research report.

“This is particularly true in retail. During the Great Recession of 2008–2009, e-commerce grew, and brick-and-mortar retail declined. As the economic recovery took hold, that trend continued while off-price, discount, and emerging players succeeded.”

Retail sales in July were flat. The Census Bureau doesn’t adjust for inflation, so in real terms, sales are likely down significantly.

And the stock market has punished retail companies. The sector declined at twice the rate of the broader market during this year’s downturn. The S&P Retail Index is down about 25 percent year to date, compared to the broader S&P 500 Index, which is down more than 12 percent.

On the ground, retail firms are noticing changes in consumer spending habits.

“The softening trend was more significant in customer segments with the lowest income profile,” Nordstrom CEO Erik Nordstrom said during the company’s second-quarter earnings call with Wall Street analysts.

Nordstrom noted that its stores had problems moving clearance inventory, leading to even bigger price cuts than anticipated.

Walmart, the retail giant that serves as a bellwether for consumer spending, saw its second-quarter earnings beat estimates, but the company noted that its stores were getting a lift from higher-income shoppers who normally don’t shop at Walmart. Dollar Tree and General Dollar, which both announced earnings on Aug. 25, saw revenue increases in the last quarter, owing to penny-pinching consumers.

Storm Clouds on the Horizon

In his weekly column, Barron’s magazine’s Jack Hough in August wrote—only half jokingly—that he regretted buying a “twin pack of 40-ounce ranch dressing jugs” from a warehouse store because he had left a coupon at home that would have given him another $3 off.

These are anecdotal evidence, but storm clouds are on the horizon.

The Commerce Department, for example, said on Aug. 26 that personal income, after taxes, rose in July by only 0.2 percent, a lower gain than in June. Consumer spending in July rose 0.1 percent, the lowest growth since it booked a decline in December 2021, and down sharply from a 1 percent gain in June.

The moderating—but far from terrible—economic data have economists divided. Some believe the U.S. economy is in good shape, pointing to the low unemployment rate, higher consumer spending, and growing wages. But others believe the real pain has yet to come.

As pandemic stimulus check funds run dry and borrowing costs remain prohibitively high, Americans will feel increasingly challenged going forward. Cautious consumers could turn even more risk averse by the end of the year, just in time for the all-important holiday shopping season.

The board has been set. How the next few months unfold could determine the trajectory of the U.S. economy for years to come.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Follow

Fan Yu is an expert in finance and economics and has contributed analyses on China’s economy since 2015.

*As an Amazon Associate I earn from qualifying purchases