We received new data today on retail sales and consumer sentiment for December and it was decidedly sobering. Holiday shoppers splurged earlier than normal in October, trying to beat bare retail shelves in November and December, while port delays, supply chain bottlenecks, rising prices, and Omicron added to the downbeat retail sales data to end the year. Retail sales dropped 1.9% in December. This was well below consensus expectations for a much more modest 0.1% decrease, and the biggest decline in 10 months as consumers became more cautious in their spending.

Sales fell in 10 of the 13 major retail categories last month, led by nonstore retail (-8.7%), department stores (-7.0%), furniture stores (-5.5%) and sporting goods stores (-4.3%). Receipts increased modestly at health and personal care stores (+0.5%) and building materials and supplies dealers (+0.9%).

Sales Declined In Most Categories In December
Despite weaker-than-expected growth last month, overall retail sales are still 16.9% higher than a year earlier on a seasonally adjusted basis, and retail sales have advanced at a double-digit pace for 10 consecutive months now.

Over the past twelve months the largest gains have been in categories where spending was limited during the early stages of the pandemic: restaurants and bars (+41.3%), gasoline stations (+41.0%) and clothing stores (+29.5%). Meanwhile, the smallest increases were in grocery stores (+8.4%) and health stores (+8.4%) where spending was already strong a year ago.

Annual Retail Sales Gains Were Universal in December
Control group retail sales – which exclude food services, auto dealers, building materials and gasoline stations and is used to approximate consumer spending in the GDP report – fell 3.1% in December. This is the biggest decline since February and suggests fading consumer spending momentum in the first quarter of 2022 as Omicron makes its presence felt.

Already consumer sentiment has been shaken by accelerating inflation and rising Omicron cases. The University of Michigan’s consumer sentiment index fell to 68.8 in January - the second lowest reading in a decade. The decline in consumer sentiment in January is broad-based with the current conditions index dropping one point and the expectations index falling 2.4 points.

There was a bit of a silver lining in the report as consumer buying intentions were modestly higher in January with the exception of those saying, “now is a good time to buy a car”, which dropped five points to 22 and is at its lowest level of the year. Clearly, the surge in used and new car prices stemming from the semiconductor chip shortage is starting to turn consumers off on making a new vehicle purchases. Those saying “now is a good time to buy a major appliance or purchase a house” rose one and three points respectively, but buying intentions are down sharply across all categories since the beginning of 2021.

Consumer Spending Outlook
Although consumer spending growth is unlikely to slow sharply on the heels of the weak December retail sales report, we are forecasting gains to moderate to a more sustainable pace over the next two years. Indeed, we expect real consumer spending growth to slip to 2.5% annualized in the current quarter, down from an estimated 3.0% in the fourth quarter and well below the double-digit gains in the first half of 2021 as Omicron ravages demand for travel, hotels, entertainment, and restaurants. Still, once Omicron recedes, perhaps by the second quarter, then record levels of household wealth, excess personal savings, healthy household balance sheets, and a tight labor market should propel a solid rebound in consumer spending gains into 2023.

Real Consumer Spending Forecast To Slow In Q1
Over the near-term though, risks are stacked to the downside and include a lack of inventory as clogged supply chains are showing scant signs of easing, a potential correction in overvalued equity markets that could pressure households to limit their spending and continued elevated inflation.

Moreover, while government income support and nominal wage growth has been robust – disposable personal income grew a strong 7.5% in 2021 – a different narrative emerges when factoring in high inflation in recent quarters. Real disposable income growth is forecast to decline at a double-digit pace from a year ago in the first quarter and remain weak until the end of this year. And if inflation remains higher for longer or accelerates, it could continue undermining households’ spending power and personal savings, limiting growth.

Real Disposable Income Growth Weak Until 2022Q4
For now, our baseline forecast is that consumer inflation will peak sometime in the first quarter of 2022 and then gradually moderate through 2023, allowing real income growth to recover and eventually become a tailwind for consumer spending again.

To learn more, check out this week’s U.S. Outlook Report.