Month: September 2024

Broad-Based Retail Weakness Despite Scant Gain

Some reports tell you everything in the headline, today’s retail sales report for August is not one of them. Yes the headline increase of 0.1% was better than the modest drop that had been expected. You can thank a smaller-than-expected drop in motor vehicle sales for that. The ex-autos line tells us more about the present state of the consumer after setting aside that big-ticket category, and here we find that sales inched only incrementally (+0.1%) higher in August.

U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Economics

There is fodder for multiple narratives in today’s retail sales report. Think consumers are finally tapped out? There is no shortage of categories in decline in August. General merchandise stores were down 0.3%, led lower by a 1.1% drop in sales at department stores. That is not what these retailers were hoping for in a key back-to-school month. Speaking of which, clothing stores were also down 0.7%. Furniture stores gave back most of the pick-up seen in July, and electronics and appliance stores saw sales fall 1.1% in August. Even food & beverage stores posted decline in August.

With that kind of broad-based weakness, the case for the unstoppable consumer is surely weakened, so how do you get a headline gain? One word answer: Ecommerce. The non-store retailer category that includes online spending is second only to autos in terms of dollars spent, and it rose a stout 1.4% in August. With some help from increased spending at drugstores and other smaller categories that explains the scant headline gain.

Source: U.S. Department of Commerce and Wells Fargo Economics

There are competing narratives about the state of the consumer at this stage of the cycle in which the Fed is poised to finally deliver on long-expected rate cuts. The question isn’t will the Fed cut rates at the conclusion of tomorrow’s monetary policy meeting, but by how much. Market participants have been parsing through each data release in recent weeks seeking the one that settles the debate. Retail sales did little to crystalize the degree of easing.

The deterioration in the labor market argues for Fed easing, yet many measures of growth demonstrate the economy is continuing to expand, including retail. But that divergence perfectly describes why this easing cycle is different and so hard to predict. Historically when the Fed starts to cut rates the economy is already in serious trouble. There are only few historic-references in which a Fed achieves the type of “soft landing” many anticipate today. The consumer may technically be unstoppable, but in recent months spending has undeniably slowed sharply. For policymakers already aware of the need to make the policy environment less restrictive, this weakening may encourage the Fed to deliver a larger cut to initiate its easing cycle.

Source: U.S. Department of Commerce and Wells Fargo Economics

Seven categories of retailers reported declines in sales last month and a pullback in some discretionary-like categories demonstrates choosier consumer behavior. Nothing in this report says everything is fine, spending has slowed. But at the same time the data don’t scream dramatic pullback in spending consistent with recession.

The retail sales data position for some upside risk to Q3 consumer spending. Control group sales, which exclude autos, gasoline, building materials and restaurants rose 0.3% in August amid upward revisions to prior months. These data feed directly into real personal consumption expenditures in GDP and position for slightly stronger goods spending that we had anticipated previously.

Some analysis tell you everything in the headline, Wells Fargo’s analysis for August is not one of them.

• Counting the number of categories in decline is rather superficial. Nonstore, miscellaneous and health care retailers, 24% of all sales and 30% of non-food-non-gas, grew their sales 1.3% MoM in August, that’s 16% a.r.!
• Control sales (ex-autos, gasoline, and building materials), which directly feed into GDP, rose 0.3% after +0.4% in July. That’s 4.3% a.r..

  

• My retail inflation proxy was flat again MoM in August. YoY it was –0.9% in August after +0.2% in June and July and +2.2% in September 2023. Retail inflation has thus declined 3 full percentage points in one year while nominal sales growth slowed only 2 pp. Real sales growth accelerated from +1.4% to +3.0% in the past year.

• Indeed, real expenditures on durable goods were up 3.4% YoY in July and real nondurables were up 1.7%. The combination was up 2.4% in July vs 2.56% one year ago. The chart below shows how close my real retail sales data is with real spending on goods. The black line is real services. All spending categories are in the 3.0% range in August.

BTW, the Atlanta Fed GDPNow estimate for Q3 rose from 2.5% to 3.0%. “The nowcast of third-quarter real personal consumption expenditures growth increased from 3.5 percent to 3.7 percent.” Goldman Sachs’ tracking is now at 2.8%.

Inflation in Canada Hits 2% Target for First Time Since 2021 Core measures decreased to average of 2.35% year-on-year

The consumer price index rose 2% in August from a year ago, following a 2.5% increase a month earlier, Statistics Canada reported Tuesday in Ottawa. That’s slower than the median estimate of 2.1% in a Bloomberg survey of economists. (…)

Excluding food and energy, the index rose 2.4% from a year ago. Services inflation rose 4.3%, while goods fell 0.7%. (…)

The inflation print is the first of two reports before the Bank of Canada’s next rate decision on Oct. 23. After the release of the data, traders in overnight swaps upped their bets for a larger-than-normal reduction at that decision, putting the odds of a 50-basis point cut at just over a coin flip. (…)

On a monthly basis, the index fell 0.2%, versus expectations for a flat reading, and rose 0.1% on a seasonally adjusted basis. (…)

Prices declined in five of eight subsectors on a monthly basis, which could trigger worries about deflation among central bank officials if it becomes a trend. Macklem has recently said the bank cares as much about undershooting the 2% inflation target as it does overshooting it. (…)

Earlier this month, Macklem reiterated that officials may cut rates by 50 basis points or more if inflation and the economy slowed faster than expected. (…)

Markets expect rates in Canada to fall to about 2.5% by July of next year — more than 50 basis points lower than they were pricing a month ago. (…)

The first Fed rate cut

(…) The last three cuts after a hiking cycle all preceded devastating bear markets. Before that, there was no real pattern. There was no discernable difference in returns based on how far the S&P 500 was from a multi-year high at the time of the first cut.

The table of maximum risk and reward across time frames shows a pretty binary result. Over the next year, stocks either enjoyed decent gains with low risk or limited gains with high risk. There wasn’t any middle ground. A decent heuristic was watching the next two weeks – if risk exceeded reward, then it was a strong suggestion that the following year would be tough. (…)

Opinions aside, the imminent cut in the Fed Funds rate has been a crap shoot for investors. There was no consistent pattern in forward returns after significant hiking cycles. The last few have been major warning signs, while most of the others were not at all. They were more consistently negative for the dollar (for a while), tech stocks (ironically enough), while being good for Treasury notes and bonds, value stocks, and defensive sectors.

Manufacturing Surprise

Manufacturing activity expanded in New York State for the first time since November of last year, according to the September survey. The general business conditions index rose sixteen points to 11.5. The new orders index climbed seventeen points to 9.4, a multi-year high, pointing to a modest increase in orders, while the shipments index rose eighteen points to 17.9, its highest level in about a year and a half, signaling strong growth in shipments. (…)

The index for number of employees came in at -5.7, pointing to another month of modest employment reductions. After a steep drop last month, the average workweek index recovered to 2.9, signaling a slight increase in hours worked.

Price indexes were little changed: the prices paid index was 23.2, and the prices received index remained low at 7.4.

Firms grew more optimistic that conditions would improve in the months ahead. The index for future business activity moved up eight points to 30.6, with 45 percent of respondents expecting conditions to improve over the next six months. However, the capital spending index fell eleven points to -2.1, dipping below zero for the first time since 2020.

This snapshot shows the rare uptick:

@ceteraIM

New orders also ticked up:

Another flash in the pan? The next two charts show expectations six months ahead. Note how rising expectations for new orders in 2021-22 faded rapidly.

Record US household wealth may increase chance of soft landing

By some financial measures, U.S. consumers are better off than they’ve been in decades.

This financial cushion could increase the likelihood that the economy’s descent will be more glide than crash. And it suggests that the take-off in the economy and markets that follows could be quicker and steeper than in previous cycles.

Federal Reserve figures last week showed that increases in home prices and the stock market lifted households’ net worth in the second quarter by $2.8 trillion to a record $163.8 trillion. Overall, household net worth soared by nearly $47.0 trillion from the pre-pandemic peak less than five years ago.

A closer analysis of the numbers behind the latest headline figures points to even stronger underlying foundations.

Net wealth as a share of disposable personal income – a broad, relative measure of the household sector’s financial wellbeing – has climbed to 785%, the highest point in two years, while household debt as a share of GDP has fallen to 71%, the lowest level in 23 years.

Even though credit card and other forms of delinquencies are on the rise, most households aren’t struggling with large debt burdens.

In short, U.S. households as a whole have generally had little trouble withstanding the 525 basis points of Fed rate hikes between March 2022 and July 2023. (…)

In the U.S., 25% of assets are held by 1% of the population and almost 80% is held by 20%, meaning rising house and stock prices have benefited a relatively small cohort of the population.

The lagged impact of multiple years of negative real wage growth and the running down of pandemic-related stimulus is starting to show. The national saving rate fell to 2.9% in July, approaching the historical lows recorded in the 2005-2007 run-up to the Great Financial Crisis.

Many households can no longer rely on excess savings and may be reluctant to borrow to fund future expenditures. Does that mean consumption will soon crater?

Probably not. For better or worse, the consumer spending engine driving the U.S. economy is fueled by the well-off. Economists at BNP Paribas estimate that the top 20% of income earners account for nearly 40% of total spending, and the richest 40% account for more than 60% of all spending.

In fact, rising stock and house prices – which, again, only benefit a sliver of the population – are expected to lift consumer spending this year by $246 billion, according to BNP Paribas economists’ estimates earlier this year. That would be the third-largest boost to U.S. consumer demand in 25 years, adding roughly 1 percentage point to 2024 GDP growth.

“Ultimately it is the labor market that will matter much more for a larger slice of households, and in aggregate, there are no significant signs of stress,” says BNP Paribas’ senior U.S. economist Andrew Husby.

Economists at Goldman Sachs reckon that consumers’ disposable personal income is actually being understated by nearly $400 billion. If so, the saving rate is an estimated 5.2%, suggesting downside risks to spending are more limited than perhaps thought. (…)

History shows that, unsurprisingly, Wall Street tends to do well after the Fed starts cutting rates. While the record is slightly mixed, U.S. stocks on average drift higher in the year after the Fed’s easing cycle ends and typically rise by as much as 20% if there is no recession, according to analysts at Raymond James.

Spending – and thus corporate earnings – could obviously slow sharply if the labor market were to crater. But that’s not most people’s base case. Even if that were to occur, the response by the Fed would likely be a reasonably solid shield for financial markets.

Consider that markets are currently pricing in 250 basis points of rate cuts between now and the end of next year – and that’s with the expectation that there won’t be a severe recession. If there is, markets could get even more help from the Fed.

So even if economic turbulence puts consumers under stress, households appear to be in as strong a position as they could hope, meaning they – and markets – are relatively well positioned to face these potential headwinds.

The “wealth defect” as I dubbed it in September 2023,  continues to sustain consumer spending in spite of the “unmistakable slowing in the labor market”.

Not only are real wages unwavering, household wealth keeps climbing well above trend, allowing the savings rate to stay historically low. The cushion is not in the savings account, it’s in housing and equities.

Importantly, the Pew Research Center found that “the wealth of lower-income households increased at a faster rate during the pandemic – 101% vs. 15% for upper-income households. Middle-income households saw their net worth increase by 29% from 2019 to 2021.

• In 2021, 62% of U.S. households lived in homes they owned as their primary residence. In 2021, homeowners typically had $174,000 in equity in their homes.
• Ownership of retirement accounts, such as individual retirement accounts (IRAs) and 401(k) accounts, is about as prevalent as homeownership. Overall, 60% of U.S. households had at least one person with a retirement account in 2021. The typical retirement account was valued at $76,000 in 2021.
• 44% of households possessed both assets.

These relative trends have likely persisted post pandemic.

Bank of America data reveal that “after-tax wage growth remains highest for lower-income households in August 2024” …

… and that households’ savings and checking balances remain well above inflation adjusted 2019 level for all income groups:

As Reuters notes, Goldman Sachs economists find that the savings rate is understated:

On the surface, a very low savings rate raises concerns around the sustainability of consumer spending, but we see several reasons why the saving rate level is probably not really as low as currently measured.

First, we estimate that two measurement biases are understating disposable personal income (DPI) by 1.7%. Interest income is understated by around $350bn (1.5% of DPI) due to the BEA’s extrapolation method to estimate net interest payments, while the BEA’s failure to fully capture immigrants in employment statistics is lowering labor income by around $40bn (0.2% of DPI).

Second, employers’ contributions to future pension entitlements have declined by around 0.4% of DPI, thereby lowering measured income but not affecting household cashflow that is relevant for saving.

Third, election-related spending by non-profits is currently raising PCE spending by 0.2% (and lowering the saving rate by 0.2pp). While such spending is recorded appropriately under the national accounts’ framework, it is probably not affecting household saving decisions and anyways should fully reverse after November’s election.

Our estimates suggest a 4.6% saving rate currently after accounting for measurement biases and a 5.2% saving rate after also accounting for adjustments that align income and spending with cashflow relevant to households. These estimates are only slightly below the average saving rate from 1990-2019 (5.8%) and support our view that downside risk to spending is more limited than commonly feared.

Another unreliable BLS data series!!! Pithy those FOMC members deciding monetary policy almost blindly.

Ed Yardeni: “In our opinion, lowering the FFR too much too fast could trigger an economic boom, in which real GDP grows at a brisk pace but with higher inflation risks. It could also trigger a 1990s style meltup in the stock market.”

Rates Markets Are Pricing in a Recession

Despite surveys showing that the consensus is expecting a soft landing, rates markets are pricing in a full-blown recession, see chart below.

BTW: