9 August 2022

U.S. Economy Transitions to Slower Growth as Inflation Weighs on Consumers

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The U.S. economy is enduring a rocky transition from an exceptionally strong recovery to a steep slowdown as rising inflation and interest rates weigh on consumers and businesses.

Economic growth surged last year, as consumers unleashed spending and businesses recovered from the short, deep pandemic recession of early 2020. But that robust growth is grinding to an abrupt halt as households, companies and policy makers face deep challenges, with four-decade-high inflation chief among them.

The Federal Reserve’s preferred inflation gauge rose 6.8% in June from the year before, the sharpest rise since January 1982, the Commerce Department said Friday. A separate measure of consumer inflation was up 9.1% in June from a year earlier. A tight labor market could continue to exert upward pressure on inflation. Wages and benefits rose 5.1% in the second quarter compared with the same period a year earlier, the Labor Department said Friday. That was the fastest rate of increase on records back to 2001, and was led by better pay for private-sector workers.

The Fed is briskly raising interest rates in an attempt to slow the economy and inflation, most recently lifting its benchmark rate to a range between 2.25% and 2.5% on Wednesday.

The central bank’s interest-rate increases have already dented the housing market and appear to be filtering more broadly into the economy, having the intended effect of cooling last year’s rapid growth. A steep decline in residential investment, a pullback in business spending and weaker inventory restocking contributed to U.S. gross domestic product shrinking at a 0.9% annual rate from April through June, the second straight quarter that economic output contracted.

Two straight quarters of shrinking economic output is a common, but not official, definition of a recession. Regardless, it does raise concerns about the economy’s trajectory and underscores that the rapid recovery from the pandemic recession is over, especially as elevated inflation shows few signs of abating.

“Growth is going to be slowing down this year,” Fed Chairman Jerome Powell said this week. “I think you pretty clearly do see a slowing now in demand in the second quarter—consumer spending, business fixed investment, housing, places like that.”

Consumer-facing companies spoke this week about business slowing as shoppers retrenched. Walmart Inc. warned that higher prices for food and fuel were causing consumers to pull back. Procter & Gamble Co. predicted its slowest sales growth in years, a sign that consumer belt-tightening was beginning to hit household staples. And Amazon.com Inc. posted a loss for a second straight quarter, hurt in part by continued weakness in its core retail operations.

“We are in a very difficult macroeconomic state,” Amazon Chief Financial Officer Brian Olsavsky said.

Friday’s economic data gives the Fed little reason to significantly slow its pace of rate increases. But its next policy meeting isn’t for eight weeks, giving officials multiple inflation and labor-market reports to study before deciding how much higher to raise rates.

At a press conference on Wednesday, Mr. Powell said “another unusually large increase” of 0.75 percentage point “could be appropriate at our next meeting,” but he also said that at some point, the Fed would want to slow its pace of increases to assess how cumulative rate rises are influencing the economy.

Fed officials pay heavy attention to wage inflation because they believe rising labor costs can lead to more persistently elevated inflation. Friday’s Labor Department report on wages “is a print that’s going to keep Fed officials up at night,” said Omair Sharif, who leads forecasting firm Inflation Insights LLC.

Wages and salaries for private-sector workers accelerated, growing 1.6% in the second quarter versus 1.3% during the first three months of the year. Higher inflation, though, is wiping out worker wage gains. Adjusted for inflation, wages and salaries paid to private-sector workers fell 3.1% in the second quarter from a year earlier, the Labor Department said.

Jerry Pugh, who owns 15 locations of suburban Atlanta-based gym franchise Workout Anytime, said many long-term employees have left for other industries or higher pay over the past year and a half, keeping the gyms in constant hiring mode. Mr. Pugh said the facilities need general managers, sales staff, personal trainers and fitness directors.

“You can still get quality employees, but the price you’re having to pay is much higher than it was before Covid,” said Mr. Pugh. “Everybody wants more money than they’ve ever wanted.”

Mr. Pugh’s gyms are paying higher commission rates to personal trainers than a year ago, and they also are paying trainers $12 to $14 an hour for “floor hours,” in which they try to pull in new members for their services. That is up from an hourly rate of $10 a year ago. The gyms recently started offering other incentives, including paying for some high-performing employees’ personal-training or nutrition certifications.

To offset some of the higher labor costs, the gyms raised rates for new members by 99 cents a month at the end of last year. The basic monthly membership price is now $19.99. Mr. Pugh said the company is weighing another price increase.

Carrols Restaurant Group Inc., which operates more than a thousand Burger King locations and dozens of Popeyes restaurants, is seeing some slight easing of wage pressures, a sign more workers could be entering the labor market.

While the unemployment rate, at 3.6% in June, is near the half-century low set just before the pandemic began, the share of adults working or looking for work remains well depressed. Attracting more workers could help cool inflation.

Average hourly wages paid by Carrols continue to rise in excess of 10% annually, but the rate of increase has cooled somewhat in more recent months, said Anthony Hull, chief financial officer of the Syracuse, N.Y.-based company. “Hiring pressures are stabilizing as we are seeing an increase in application flow,” Mr. Hull said on an earnings call.

Companies say they are monitoring consumer behavior and how inflation is affecting shopping patterns.

“Over the past several months, we have seen many consumers begin to cut back on discretionary spending, including eating out less at restaurants,” Hershey Co. Chief Executive Michele Buck said.

Ms. Buck said the candy maker has seen minimal impact across its portfolio of products, but it started to see more in recent months and expects such resistance to increase later this year. As a result, the company is working with retailers on implementing its future price increases.

Higher inflation helped drive an increase in household spending last month. Consumers boosted their seasonally adjusted spending by 1.1% in June, up from 0.3% increase in May, the Commerce Department said Friday. After adjusting for inflation, spending was nearly flat as consumers paid significantly more for gasoline and other energy products in June. Pump prices have more recently fallen.

Kimberly-Clark Corp., maker of Huggies diapers and Kleenex tissues, said consumers and businesses paid more for its products but bought less, sending sales volumes down 1% for the most recent quarter. The company raised revenue expectations for the calendar year, but predicted that higher costs for everything from pulp to shipping will eat into profitability more than anticipated.

Looking ahead, Kimberly-Clark CEO Mike Hsu said the company faces a difficult balancing act in making budget-friendly products available without pushing consumers toward cheaper alternatives.

“There is a segment of consumers who are trading down, but it’s not all consumers,” Mr. Hsu said. “We want to be very cognizant that we don’t move the whole market that way. There are plenty of consumers that, despite the impact of the economy…they are still looking to trade up.”

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