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Retail Sales Stagnant On Higher Inflation Rising Rates

Scott Anderson
Chief Economist
Bank of the West

Fears of an imminent U.S. recession subsided a bit with this week’s economic data. The NFIB Small Business Optimism index unexpectedly improved to 92.1 in September from 91.8 in August. A high percentage of small businesses are still able to pass along higher prices to their customers, and future sales expectations for small businesses improved a bit last month. Also, a solid 23% of small businesses continue to plan to hire more workers.

Taking a peak into what October may have in store, the University of Michigan’s preliminary Consumer Sentiment Index for October exceeded analysts’ forecasts, improving to 59.8 from 58.6 in September. Consumers’ view of current conditions improved visibly from a month ago with a higher percentages of consumers seeing now as a good time to buy a major household appliance or vehicle, though expectations about the future continue to deteriorate.

Consumer Sentiment Has Improved Since June
These two surveys offer some tantalizing hints about the health and the state of mind of the consumer in the face of unrelenting inflation and tight labor markets, but the September Retail Sales report, released this morning, provides even better insights into consumer goods spending. Nominal retail sales stagnated on higher inflation and rising interest rates in September and spending momentum has been on a down trend over the last several months, but retail sales have not yet buckled under the pressure like they would at the start of an outright recession. Over the past three months nominal retail sales have increased at a 2.6% pace, down from 5.5% in August and a whopping 17.0% annualized pace back in April. In inflation adjusted terms, real retail sales declined 4.5% annualized last month and are now flat from a year ago.

Still the fingerprints of high inflation and rising interest rates are growing more visible in consumer spending patterns and how they chose to allocate their dwindling spending power. Consumers scaled-back their spending on electronics, furniture, motor vehicles, and building materials as financing costs rose and they focused more of their spending on necessities like food, health care, and clothing. A softening labor market, rising interest rates, and declining real income growth are expected to only further add to consumer headwinds in the months ahead.

Consumers Scale-Back on Cars, Furniture, and Electronics
The number one problem for U.S. consumers and the Federal Reserve is high and intractable U.S. inflation. The September CPI report was unequivocally disappointing. Rapid 10% annualized price increases for services, owners’ equivalent rent, food, medical care, and airfare last month more than wiped out the benefits of declining prices for gasoline and used cars. Housing is a huge chunk of the problem today, comprising a hulking 42% of the overall index.

Double Digit Price Inflation Still Widespread
The Core CPI measure that excludes volatile food and energy prices jumped to a new post-pandemic high of 6.6% year-on-year, the second consecutive monthly increase and more than reversing the deceleration seen in this measure from April through July. So high U.S. inflation is now a widespread problem and has spread beyond good sectors to sectors like services, housing and medical care where prices are notoriously sticky and difficult to influence. In short, the Fed rate hikes and quantitative tightening to date have had no visible impact on their goal of bringing core inflation back down to a more manageable 2.0% pace. Bottom-line, the Fed is going to have to do more monetary tightening than they thought just a few months ago and will probably have to push the U.S. economy into recession to get to their ultimate destination of a return to 2.0% inflation.

High and Sticky Core Inflation A Huge Problem
It is little wonder then why Fed funds rate expectations and Treasury bond yields have been on a one way trip higher this week as investors speculate that the Fed will need to raise rates at least as high as the median dot-plot forecast projected in September and may have to go even higher to break the back of inflation.

This week’s retail sales and other data raise the prospect that third quarter real GDP will increase somewhat faster than our current forecast of 1.9%, but we maintain our forecast that we will see a major slowdown in economic growth starting in the fourth quarter and likely progressing in the first half of 2023 into at least a mild recession that will materially cool the U.S. labor market and push the unemployment rate higher.

To learn more, check out this week's U.S. Outlook Report.

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