High interest rates and slower economic growth are expected to put increasing pressure on retail profits this year, but, on the bright side, many economists expect inflation to decrease to desired levels by year-end
By Phillip M. Perry
Fasten your seat belts, and enjoy the ride. Like airline travelers bracing for expected turbulence, U.S. retailers are likely to experience a tricky operating environment in 2024. On the upside, the economy will continue to grow although at a slower pace. Unemployment remains low, capital investments are plugging along at a healthy pace, and the all-important housing market is burgeoning. On the downside, higher interest rates established by the Federal Reserve to control inflation are putting some downward pressure on business activity and shoppers’ buying habits. Economists are taking note by lowering expectations for the next 12 months.
“[This] year will continue to be a difficult environment for retailers,” says Scott Hoyt, Ph.D., senior director of consumer economics for Moody’s Analytics, a global economic analysis and forecasting firm based in New York, N.Y. “We’re expecting 2.5 percent retail sales growth for 2024, [almost half of] the 4.7 percent growth expected when 2023 numbers are finalized.” When adjusted for inflation, Hoyt notes, retail sales are expected to be flat for both years.
The slowdown comes on the heels of a healthy 9.3 percent retail sales increase clocked for 2022, a time when pandemic-era shoppers were still loading up on goods for their homes. Those days are gone, and retailers should expect shoppers to continue to spend more on services rather than merchandise. Hoyt feels that spending on categories such as recreation, travel and entertainment is still below pre-pandemic levels. “I think we have another year in which the shift toward services is going to be something retailers need to deal with,” he states.
Retail’s current position is a reflection of a deceleration in the larger business environment. “We expect real GDP [Gross Domestic Product] to grow 1.4 percent in 2024,” says Bernard Yaros Jr., assistant director and economist at Moody’s Analytics. (GDP is the total value of the nation’s goods and services.) That’s slower than the 2.1 percent increase expected when 2023 numbers are finally tallied, and it’s below the 2.0 percent to 3.0 percent considered emblematic of normal business growth. GDP is the most commonly accepted measurement of economic growth, and “Real” GDP adjusts for inflation.
Slowing commercial activity will affect bottom lines. Moody’s Analytics expects a decline of 4.5 percent in corporate profits for 2023 and only a modest recovery of 0.3 percent in 2024.
Reports from the field confirm these economists’ readings. “Our members are experiencing a business slowdown, due largely to increasing interest rates,” says Tom Palisin, executive director of The Manufacturers’ Association, a York, Pa.,-based regional employers’ group with more than 370 member companies. While businesses understand the need for higher interest rates, they nevertheless hope for early relief. “If inflation does not continue to drop, interest rates will have to be increased further, which will be a big problem,” says Palisin.
So, are the Federal Reserve’s efforts to reduce inflation by raising interest rates paying off? There’s some good news here, as well as a sunny forecast. Moody’s Analytics expects year-over-year consumer price inflation to average 3.2 percent when 2023 numbers are finalized, down from more than 6 percent in 2022. Moreover, the number should continue to drop until it reaches the Fed’s target rate of 2 percent late in 2024. (These figures represent the Personal Consumption Expenditures [PCE] Price Index—a measure of how consumers spend their money and whether they save rather than spend—which strips out food and energy prices and is the Federal Reserve’s preferred measure of inflation).
Indeed, Moody’s Analytics believes the Fed will start to lower interest rates around June 2024—although more slowly than previously anticipated because of persistent inflation and ongoing labor market tightness. Cuts of about 25 basis points per quarter are expected over the next few years until the Federal Funds Rate—the interest rate that banks and other depository institutions charge each other for overnight loans—reaches 2.75 percent by the fourth quarter of 2026 and 2.5 percent in 2027.
For retailers, declining inflation is a two-edged sword. On the positive side, it encourages shoppers to spend more. On the negative side, it gives retailers less power to raise prices. And once inflation is taken into consideration, retail sales are expected to be virtually flat for both 2023 and 2024.
THE LABOR MARKET
Shoppers open their wallets more quickly when they are feeling good. “Consumer confidence has been trending higher, and I think prospects are good for it to improve [in 2024],” says Hoyt.
A healthy job market is a major driver of consumer confidence. “The unemployment rate has been low, bouncing around between 3.5 percent and 3.8 percent for some time,” Hoyt continues. “We think unemployment will trend upward a bit, ending 2023 around 3.9 percent and 2024 around 4.2 percent.” (Many economists peg an unemployment rate of 3.5 percent to 4.5 percent as the “sweet spot” that balances the risks of wage escalation and economic recession.)
Low unemployment may fuel happy sentiments among citizens, but it presents retailers with two practical challenges. The first is the need to raise wages to attract sufficient workers. “Wage and salary income growth has been strong, fueled by a tight labor market,” Hoyt notes. “We’re expecting it to increase to just over 5 percent both for 2023 and 2024.” In 2022 the growth was a little over 8 percent.
Reinforcing the estimates of some economists, Palisin says his members have had to hike their compensation to remain competitive among themselves and other economic sectors. The group’s entry-level hourly wages increased an eye-popping 8 percent to 10 percent in both 2022 and 2023, far higher than the historic average of 2.5 percent to 3.0 percent.
Problem No. 2 is a scarcity of workers. Inability to hire enough people—particularly of the skilled variety—can affect bottom lines. Two problems contributing to a labor shortage are the retirement of baby boomers and a post-pandemic reordering that many people are making of their life goals. “Some demographic structural things happening in the U.S. mean that we just don’t have, in many cases, the number of workers needed to meet demand,” says Palisin. “And that’s not going to change.” Little wonder employers are turning their attention to retaining the talent they have.
THE HOUSING MARKET
Given the generally upbeat consumer sentiment, prospects are good for the housing sector in 2024. That favors retailers because home buyers tend to load up their shopping carts at stores. “New home sales are running at the top end of the range set in the decade preceding the pandemic,” Yaros informs. “One reason is that a lack of existing inventory is pushing buyers to consider new homes. The construction industry is stepping in to close the gap, and housing starts have exceeded expectations.”
The construction of new homes is being fueled by a cold hard fact: There aren’t enough existing homes to meet demand. “The current 3.1 months’ supply of existing homes remains well below the four to six months of inventory that is considered a balanced housing market,” Yaros continues. Strong demand caused a 10.3 percent increase in the median price for existing homes in 2022, and a 0.6 percent increase in 2023. A correction of 1.1 percent is expected in 2024.
For an explanation of the scarcity, look no further than the run-up in mortgage rates. The ultra-low interest rates of existing mortgages amount to a strong financial incentive for existing homeowners to stay put. “Many current homeowners had refinanced their investments at 3 percent or 4 percent,” notes says Bill Conerly, Ph.D., principal of Conerly Consulting in Lake Oswego, Ore. “Replacing what they have with better homes would require walking away from those mortgages to take on new ones at 7 percent. I think we’ll see this trend continue for throughout 2024, but I also think we’ll see a lot of strength in remodeling, and that will be financed probably with home-equity lending or second mortgages.”
High interest rates, an inflationary environment and rising worker wages are a trilogy of challenges that typically dampen business confidence. And there are other threats to corporate well-being, as well, such as increasing energy costs and an appreciation in the U.S. dollar that hampers export activity.
Despite all this, many companies don’t seem to be planning any dramatic adjustments to their operations, in marked contrast to their cautious attitude of a year earlier. “While our members have moderated their expectations for the future, they are still feeling slightly positive,” says Palisin. “One reason is that we seem to have avoided the recession that many were predicting.” Moody’s Analytics believes that the nation will avoid a recession in 2024, attributing its forecast of a “soft landing” to resilience in labor markets, a robust housing market and consumer confidence. (A “soft landing” refers to a moderate economic slowdown following a period of growth. It is what the Federal Reserve aims for when it raises interest rates to curb inflation and cool a hot economy without setting off a significant decline in economic activity [recession]).
Businesses looking to borrow funds to fuel capital investments, though, had best prepare for a tougher negotiating environment. “The banking sector is in retrenchment, and lenders are becoming more risk averse,” says Anirban Basu, Ph.D., J.D., chairman & CEO of Sage Policy Group in Baltimore, Md. “As a result, developers are having more difficulty lining up financing.” Fueling the concern among financial institutions is a recent spate of loan delinquencies and bankruptcies. Banks are looking at their portfolios and seeing where they can tighten. Companies holding inexpensive pre-pandemic loans will see an earnings hit when they need to refinance at six or seven percent.
WHAT TO WATCH
In the opening months of 2024, Hoyt suggests that retailers look at employment levels to get an early read on how the year will go. “The first thing retailers should always watch is the state of the labor market, especially with job growth slowing,” Hoyt explains. “That’s vitally important for retailers because consumers need job growth to have the income growth that results in retail sales growth.”
The second important key indicator will be trends in oil and gasoline prices. “If fuel prices stay in their recent range, that’s good news for retailers,” Hoyt continues. “If they spike again, which is not inconceivable given everything going on in Russia, the Middle East and elsewhere in the oil-producing world, that would cause a severe problem for retailers because it would force consumers to spend more of their budgets on energy and less on goods.”
Whatever the condition of the tea leaves, retailers will encounter a tougher operating environment in 2024. “This year, we will face uncertainty about inflation and interest rates, labor shortages, rising energy costs, a slowdown in China’s economy and recurring threats of a federal government shutdown,” says Palisin. “There are a lot of spinning plates in the air, and some of them may fall and crack.”
PREPARE FOR A SOFT LANDING
U.S. Gross Domestic Product (GDP) Annual Percent Changes
Many economists expect growth in the monetary value of goods and services produced and bought in the U.S. to slow even further in 2024.
2014: +2.3 percent
2015: +2.7 percent
2016: +1.7 percent
2017: +2.2 percent
2018: +2.9 percent
2019: +2.3 percent
2020: -2.8 percent
2021: +5.9 percent
2022: +2.1 percent
*2023: +2.1 percent
*2024: +1.4 percent
The World Bank
* Projections by Moody’s Analytics