What recession? Americans are still powering the economy despite high inflation

Key economic indicators, such as huge retail sales and historic job gains, are painting the picture of a robust economy that shows few signs of slowing down.

But a smaller-than-expected drop in January inflation has some economists worried that the Federal Reserve is going to prolong its interest rate hikes, which could tip the economy into a recession that puts millions of people out of work.

The consumer price index (CPI), a key gauge of inflation, has fallen for seven months in a row, dropping to 6.4 percent annually in January off a high of 9.1 percent last June.

Markets had been expecting the CPI to land at 6.2 percent, cueing a chorus of economists who want the Fed to press ahead with its rate hikes.

While the Fed says it’s pursuing a “soft landing,” meaning lower inflation without a serious recession, it expects its rate hikes to boost the unemployment rate by 1.2 percentage points, according to December projections, which would likely mean losing at least 1 million jobs.

Here’s a look at how the economy is fighting off a recession amid a grueling battle with stubborn inflation.

Americans haven’t stopped spending despite higher prices

Retail sales rose 3 percent in January, according to Commerce Department data released Wednesday, the biggest monthly gain in nearly two years. 

The increase, driven by an uptick in auto sales and spending at restaurants and department stores, indicates that U.S. consumers are powering through even as inflation and higher borrowing costs hinder their purchasing power.

It’s yet another indicator that the U.S. economy isn’t in a recession and may actually be gaining steam. Analysts predicted that retail sales would rise just 1.8 percent after falling 1.1 percent in December. 

Read more: ‘You just can’t really afford to live like you were before’: Here’s how Americans are feeling the strain of inflation

“If you look at the consumer, they keep spending money,” Bank of America CEO Brian Moynihan said at an investment conference Tuesday. 

But the data is sure to worry Fed officials, who want consumers to spend less so that companies are forced to bring prices down. 

“Although resilient consumer spending is a positive sign for the health of the economy, renewed demand for supply-constrained categories could add to inflation pressures, potentially eliciting more aggressive action from the Fed,” Kayla Bruun, economic analyst at Morning Consult, wrote in a Wednesday research note.

The country has the strongest job market in a half-century

The U.S. economy added 517,000 jobs in January, blowing past expectations and cutting the unemployment rate to 3.4 percent, its lowest level since 1969.

Wage growth can heavily influence the prices businesses charge, so higher levels of unemployment are generally associated with lower costs for consumers.

The decline in inflation amid low unemployment has left economists searching for which parts of the economy are preventing prices from falling faster.

One increasingly cited area is the “core services excluding housing” category, which includes labor-intensive businesses like nail salons, restaurants and barber shops.

Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, described this sector as “very tied to the labor market,” and the White House recently analyzed it with a new, specially calibrated wage statistic.

The White House analysis found that despite sticky inflation in this sector, wages there have been rapidly decreasing, suggesting that wages aren’t the primary driver of inflation.

“I’ve been a server for many years … and servers are not making as much,” Kianna Quann, a manager at the City Cafe diner in Chattanooga, Tennessee, told The Hill in a phone interview. “The most I know a server makes is $2.13 [an hour], because they depend on tips.”

Quann said that despite the lower take-home pay she’s observing at her workplace, server jobs are still in high demand and that people want to be working.

“We’re getting a lot of applications right now, and it varies in age. Not just young people, everybody, I guess. People are getting back to work, and the most appealing job is a job where you can take home cash every day. So people are gravitating toward server jobs.”

Strong profits and GDP signal a growing economy

Companies have been posting record profits in the recovery from the coronavirus pandemic, another sign that the U.S. economy isn’t close to a recession.

Corporate profits before the pandemic generally stayed between $1.6 and $2 trillion dollars annually, without being adjusted for inventories and capital consumption, according to federal data.

But since the pandemic, profits have climbed above $2.8 trillion and even topped $3 trillion in the second quarter of 2022. Inflation-adjusted profit as a share of value added to the economy has gone up from about 12 cents on the dollar before the pandemic to 17 cents in the third quarter of 2022.

Gross domestic product (GDP) grew 3.2 percent in the third quarter of last year and 2.9 percent in the fourth quarter.

Here’s who is losing out on the nation’s booming economy

Not all Americans are sharing in the prosperity of the new post-pandemic era of higher profits.

Kimberly Martin, a resident of Newark, New Jersey, who had to move into a homeless shelter after she lost her job, told The Hill she thought the commercial real estate sector was crowding out opportunities to build housing for people who actually need it.

Housing woes are pressing: Biden barely mentioned the deflated housing market. What’s next for renters, buyers and owners?

“Every time they put up an apartment building, it’s a luxury two or three-bedroom [apartment building], and there’s people who have been in shelters for years,” she said.

“I know men who hold down jobs, but they still have to go look for a rooming house. Why can’t you dedicate a building with nothing but studios, just studios?” Martin said. “Just something that we can afford,”

High inflation could still force Fed’s hand

Prices are coming down, but not fast enough to bring relief to working families or satisfy the Fed. 

Core prices, which excludes food and energy prices and is closely watched by the Fed, rose 0.4 percent in January, unchanged from December and an uptick from November. The increase was driven by higher housing costs, with rent rising 0.8 percent in January.

The Fed, eager to avoid high prices from becoming the new normal, has said it is willing to boost rates high enough to cause an economic downturn or even a full-blown recession.

Financial markets are predicting that the Fed will implement two additional 0.25 percentage point interest rate hikes, minor moves meant to slowly cool the economy, during its next two policy meetings. 

But several Fed officials said this week that stricter measures may be in order, even if they raise the risk of a recession later in the year.   

Dallas Fed President Lorie Logan said Tuesday that the central bank “must remain prepared to continue rate increases for a longer period than previously anticipated.”

Some economists remain hopeful that a “soft landing” is still possible, noting that the government’s data on rents is typically delayed by several months, and private sector data shows that rents are falling. 

“It could be the tale of two halves for inflation this year. Stronger than expected inflation in the first half and a more significant deceleration in the second half,” Oxford Economics chief U.S. economist Ryan Sweet said in a research note.