Sizzling Retail Sales Scorch Rate Cut Expectations
The American consumer’s strength may be the force that wrestles the market out of the conviction that the Fed will cut interest rates this March.
The Department of Commerce said that retail spending rose in December at the fastest pace in three months. Overall sales were up 0.6 percent, easily topping Wall Street’s estimate for a 0.4 percent increase and double the already surprisingly strong gain of 0.3 percent in November. Compared with a year ago, sales were up 5.6 percent.
Excluding auto dealers and gas stations, retail sales were also up 0.6 percent. Auto sales were strong, rising 1.1 percent, but gas station sales fell, reflecting a 19-cent decline in gasoline prices.
There’s no doubt that holiday shopping was a big boost. Sales at department stores soared three percent for the month, and online sales jumped 1.5 percent. Sales at the category that includes sporting goods stores, hobby stores, and bookstores rose 0.3 percent.
The picture that emerges is one of a very strong consumer, likely buoyed by ongoing strength in the labor market. The economy added 216,000 jobs in December, far more than expected, and the unemployment rate remained at an ultra-low 3.7 percent.
The End of Goods Deflation
Importantly, retail sales represent demand for goods. The headline number includes restaurants and bars, part of the services sector, but sales in those places were flat for the month. The increase came from the goods part of the economy.
That’s supposed to be the part of the economy where demand is falling. It’s been the source of disinflation for most of this year, with prices of some goods actually deflating. The surge in retail sales we have seen in the fourth quarter of the year suggests that demand for goods could start adding to inflationary pressures.
The slice of retail sales from what’s known as the “control group” rose 0.8 percent, twice as much as expected, and the prior month’s figure was revised up one-tenth of a point to show a 0.5 percent gain. This feeds directly into estimates of gross domestic product through the personal consumption expenditure gauge. The bigger than expected gains in this figure suggest that estimates of economic growth at the end of the year will have to be revised up.
Maybe the Jobs Numbers Were Right
The surge of holiday shopping also suggests that the December jobs numbers may not be revised down as much as some analysts had thought. Throughout last year, many of the surprisingly strong jobs figures were later subject to downward revisions. And the December numbers were so small that many economists suspected they would be revised down by a lot. In Tuesday’s talk with the Brookings Institution, Federal Reserve Governor Chris Waller hinted he was expecting a downward revision to the December jobs figure.
Those revisions may still happen, but they may be smaller than Wall Street thinks. With people out shopping for goods as much as the retail sales numbers indicate, businesses were swamped with demand and likely hiring to keep up.
The report on import prices also suggests very strong demand. This is again a category that is dominated by goods sales. Prices were expected to fall by 0.6 percent. Instead, they were flat for the month.
The realization that the trouble in the Red Sea is not likely to be resolved quickly is also causing doubts about further disinflationary pressure from goods. Supply disruptions that occur in the context of full employment can have outsized effects on inflation. So, the shutting down of the Red Sea shipping lanes is likely to put upward pressure on goods prices.
The Odds of a March Cut Get Cut Down to Size
The market reacted violently to these developments. Two days ago, the swaps market was implying a 77 percent chance of a cut in March. By midday Wednesday, following the release of the retail sales numbers, the odds had fallen to 52 percent.
Those dreaming of a March cut may finally be waking up to reality.