After two years of frenetic activity fueled by a post-pandemic recovery, retailers will confront a tougher operating environment in 2023. Growing headwinds include high inflation, climbing interest rates, a rapidly softening housing market, continuing supply chain disruptions, declining capital investments, and escalating costs for wages and energy.
“2023 is likely to be a challenging year for retailers,” says Scott Hoyt, senior director of consumer economics for Moody’s Analytics (economy.com). “We are projecting growth of only 2.8% — well below the sector’s historic 4.3% average.” The forecast represents a decline from the 8.3% increase expected when 2022 numbers are finally tallied. The recent trend is well below 2021 with its 17.5% increase fueled by a consumer shift away from services and toward goods.
“Of the many factors weighing on growth, the biggest will be a slowdown in inflation, since retail activity is measured in nominal terms,” says Hoyt. Moody’s Analytics forecasts that, by the end of 2023, inflation will have declined from its recent 7.1% for the 12 months ended November 2022 something close to the 2% target favored by the Federal Reserve.
Inflation is kind of a two-edged sword, since it helps raise merchandise prices while dampening shopper behavior. While retailers will be hurt by a decline in inflation over the coming 12 months, rising prices have not been a panacea in 2022.
“Inflation is particularly pernicious for retailers right now because it is running higher today for goods than for services,” says Hoyt. “That has been encouraging consumers to switch to more spending on the latter.”
As for the current state of shopper psychology, it remains as unsettled as it was a year ago. “It’s hard to get a handle on consumer confidence right now,” says Hoyt. “If you ask people about their finances and they think about the stock market or gasoline prices compared to a year ago, they’re really depressed. If you ask them about the labor market and their job situation, they’re feeling pretty good.”
Other factors that will weigh on retail activity in 2023 include the loss of some helpful economic initiatives. “Government stimulus packages, ultralow interest rates, and strong money supply creation had been helping to compel business activity until mid2022,” says Anirban Basu, chairman & CEO of Sage Policy Group (sagepolicy.com). “All those fundamentals have been inverted.”
The deceleration in retail operations is echoed in the larger economy. “We expect real Gross Domestic Product (GDP) to increase by 0.7% in 2023,” says Bernard Yaros Jr., assistant director and economist at Moody’s Analytics (economy.com). “The projection for 2022 is 1.7%. Both figures represent much slower activity than the 5.9% increase of 2021.” (GDP, the total of the nation’s goods and services, is the most commonly accepted measure of economic growth. “Real” GDP adjusts for inflation.)
Reports from the field support the analysis of economists. “In the first half of 2022, many of our members were still experiencing high demand,” says Tom Palisin, executive director of The Manufacturers’ Association, a York, Pa.- based regional organization with more than 390 member companies (mascpa.org). “But as the year progressed, there was a significant slowdown caused by the labor shortage, inflationary issues and global events.”
With its diverse membership in food processing, defense, fabrication, and machinery building, Palisin’s association is something of a proxy for all American industry. The good news is that strong employment conditions at the association’s members — as well as at companies elsewhere in the nation — is helping alleviate the negative impact of the economy’s headwinds. Moody’s Analytics expects a continuation of that favorable condition, forecasting an unemployment rate of 4.1% by the end of 2023. That’s not much higher than the 3.7% rate of late 2022. (Many economists peg an unemployment rate of between 3.5% and 4.5% as the “sweet spot” that balances the risks of wage escalation and economic recession).
High employment levels tend to spark wage increases that fill workers’ pockets with cash to spend at retailers. “Wage rates, as measured by the Employment Cost Index (ECI), remain very high by the standards of the last couple of decades,” says Hoyt. Increases in 2023 are expected to come in at 3.7%, a healthy level that reflects the strong growth of a tight labor market. “While we’ve had growth over 3% for the last three years, prior to 2020, the last time we had growth in the ECI of over 3% was 2007.” On the flipside, higher wages increase operating costs that can dampen profits.
The tight labor market hits profitability not only in the form of higher wages, but also in a scarcity of the very workers needed for retail operations. “Employers will be very focused on labor availability in 2023 as Baby Boomers continue to retire, and the supply of immigrant labor has yet to fully recover from severe pandemicrelated disruptions,” says Yaros. “Despite a slowing economy, layoffs are low, indicating that businesses are holding onto labor in a reaction to the hiring difficulties they encountered during the pandemic.”
When will the available workforce grow? Not anytime soon, say observers. “The labor market is going to be tight for years to come,” says Bill Conerly, principal of his own consulting firm in Lake Oswego, Ore. (conerlyconsulting.com). “The decade from 2020 to 2030 is expected to have the lowest growth of the working age population since the Civil War. One reason is the retirement of the Baby Boomers; another is the low rate of immigration over the last few years.”
Palisin agreed that a labor shortage is going to be a long-term condition, and said his members are making moves to lessen the effect. “Employers are trying to be creative in the way they keep and retain workers, not only by offering higher salary rates but also by extending benefits and encouraging work flexibility. They are also investing more in automation for labor-intensive tasks.”
Higher wages and scarce workers are not the only forces threatening retail profits. Another major factor is a rise in interest rates — the Fed’s favorite tool for fighting inflation. “The purpose of increasing interest rates is to drive down demand,” says Palisin. “So, our members are expecting to see a decrease in new orders that will impact the overall economy. Many of our companies have lines of credit that rely on floating interest rates, too. Rising rates will take a hit to the bottom line as companies decide whether to utilize those lines of credit to support their cash flow and investments.”
Adding downward pressure is the disruption in the delivery of goods that continues to plague retailers large and small. “Supply chain problems have improved over the past year, but there hasn’t been the significant resolution we had hoped for,” says Palisin. “Random shortages in materials and deliveries are still plaguing our members, and that’s leading to backlogging of orders. Companies just can’t get materials or parts.”
The Russia-Ukraine war has worsened the situation, noted Palisin. “The war has created an energy crunch and a disruption in raw materials from that region that have trickled through the economy to exacerbate supply chain issues.” Companies are responding by expanding their sourcing from countries other than China.
Buyers of homes tend to shop a lot at retailers, and that sector is also entering a period of correction. “The underlying dynamics of the housing market are changing as lower affordability spurred by higher prices and mortgage rates is weighing on demand,” says Yaros.
The rise in prices is discouraging consumers from signing on the bottom line. Median prices for existing singlefamily homes are expected to increase 11.5% when 2022 figures are finally tallied. That comes off of a strong 18% increase in 2021. Any relief will only come in 2023, when prices should decline by 2.6%. While affordability has sunk to its lowest level since late 2007, the 30-year fixed mortgage rate is within striking distance of its highest level in over a decade, leading to a decline in purchase applications.
Tight housing supply is only adding to upward pricing pressure. The inventory of for-sale homes remains historically low, and new ones will be scarce on the ground. “We expect housing starts to fall by 1.8% and 2% in 2022 and 2023, respectively,” says Yaros. “This compares with a 15.1% increase in 2021.”
There’s only so much the industry can do to bolster housing supply — one big reason being the above-mentioned labor shortage. “The unemployment rate for experienced construction workers is about as low as it’s ever been,” says Yaros. “Capacity limits have delayed housing completions and contributed to a record number of housing units in the pipeline.”
One bright spot in the housing picture: Mortgage credit quality has never been better. “The percent of loans delinquent and in foreclosure is at a record low,” says Yaros. “This goes to the stellar underwriting standards since the financial crisis, and borrowers’ credit scores are much higher.” While lending standards for mortgage loans are now tightening, the credit spigot is unlikely to seize up as it did during the financial crisis of 2008.
Given the above concerns, it’s little wonder business confidence is taking a hit. “Retailers are worried about a number of things right now,” says Hoyt. He offers the following comments on the most important ones:
- Inflation — “While it does bump up retailers’ nominal sales, it also undermines consumer confidence and spending.”
- Worker scarcity — “Retailers are having to pay a lot to get staff, and turnover is high.”
- The post-pandemic shift to service spending — People are spending more on travel, hotels and restaurants.
- Rising interest rates — This is another depressant on shopper activity.
- Recession risk — “There’s a lot of talk about the high probability that the Fed won’t get this right. A recession is never good for retailers.”
- Supply chain issues — “Delivery disruptions translate into higher costs for merchandise and higher inflation, which eats into real spending and consumer confidence.”
Uncertainty about all of the above is the name of the game, and that makes planning difficult. “We are faced with a kind of two-sided coin,” says Palisin. “The positive side represents strong current orders and a continuing need for more workers, while the negative side represents inflationary pressures and global headwinds.”
Which side of the coin will show its face in 2023? Economists advise keeping an eye out for a few key leading indicators. “In the early part of the year, retailers should watch what is happening to the cost of money,” says Basu of Sage Policy Group. “Inflation is the driver of near-and-medium term economic outlooks.” A second vital element, he says, is the employment picture. “Employers should watch for any emerging weakness in the labor market.” Finally, what about consumers? “Any softening of spending would point to a looming recession.”