Higher Interest Rates Are Taking a Toll on the Economy

• Retail sales fell 0.6% in November, well below consensus expectations. The weakness was broad-based, and particularly notable in housing-related industries.
• Industrial production fell 0.2% in November, including a 0.6% decline in manufacturing.
• Tighter monetary policy is weighing on the US economy at the end of 2022.
• PNC expects a mild recession in 2023.

Retail sales fell 0.6% in November from October, against expectations for a 0.4% increase. Sales were weak across the board, with a decline of 0.2% excluding autos, and a decline of 0.2% excluding autos and gasoline. Sales of autos and parts fell 2.3%, with gasoline sales down 0.1%.

Sales in most segments declined, with food and beverages (up 0.8%) and restaurants and bars (up 0.9%) the major exceptions. Housing-related sales fell as higher mortgage rates push down home sales; sales of furniture and home furnishings were down 2.6%, with sales of building materials down 2.5%. Sales of electronics and appliances fell 1.5%, and sales at nonstore retailers (primarily online) fell 0.9%.

Sales were strong in October, however, with a growth of 1.3% (unrevised). Sales fell 0.2% in September, revised down from no change.

Industrial production fell 0.2% in November, weaker than the consensus expectation of an increase of 0.2%. Manufacturing output fell a large 0.6% over the month, including a drop of 2.8% for motor vehicles and parts as supply chains remain a problem. Mining output fell 0.7% as lower energy prices were a drag. Utilities output rose 3.6% after unseasonably warm weather in October.

The capacity utilization rate fell to 79.7% in November from 79.9% in October. The manufacturing capacity utilization rate fell to 78.9% in November from 79.5% in October. Lower capacity utilization rates will reduce near-term inflation.

Growth is slowing in late 2022 as tighter monetary policy is weighing on the economy. Higher interest rates are causing the most slowing in interest-rate-sensitive industries like housing, consumer durable goods, and business investment; these impacts are starting to show up in retail sales and industrial production.

The Federal Reserve is hoping that higher interest rates will reduce demand in interest-rate-sensitive industries and lead to slower economic growth and lower inflation, without causing a recession. But with the central bank aggressively raising both short-term and long-term rates throughout 2022, and further fed funds rate hikes likely in early 2023, the most likely outcome is a mild recession starting in the spring of 2023.