KEY DATA: CPI: +0.2%; Excluding Food and Energy: +0.1%/ Sales: +0.4%; Excluding Vehicles: +0.3%/ Real Hourly Earnings: +0.1%
IN A NUTSHELL: “The rising costs that businesses are facing have yet to translate into significant increases in consumer prices.”
WHAT IT MEANS: This week we saw that the goods businesses buy have been rising in cost. But that doesn’t mean firms are passing those costs along, at least not yet. Consumer prices rose moderately in April driven largely by jump in energy costs. Gasoline, electricity and natural gas costs all rose sharply. Otherwise, this was a pretty tame report as a number of goods posted declines. Prices of vehicles, both new and used, apparel and medical commodities were all down. It is interesting to note that medical services and commodity prices paid by consumers have been relatively modest and the medical care inflation rate has decelerated for the past seven months. It is now below 3%. Housing is one place where consumers are seeing consistently higher prices. Excluding food and energy, inflation has come off and is now below the Fed’s 2% target, though it remains above it for all consumer goods.
For the economy to pick up steam, consumers will have to spend a lot more than they did in the first quarter. They are doing that to some extent. Retail sales rose moderately in April as sales of motor vehicles rebounded. The vehicle sales rate, however, remains below where most manufacturers want to see it. But the really good news was that households went out and bought lots of electronics, building materials and to deal with the chaos in Washington, medical products. They ate out at a decent pace and online sales were strong. There was a rise in gasoline spending, but there was also a much larger rise in prices, so people may have actually cut back on their driving. The mid-April timing of Easter could have pulled some March spending forward, so we need to be careful in concluding that consumers are back out buying things.
Can households continue to pick up their spending pace? Yes, but not by much. Real earnings, which adjusts for inflation and represents spending power, rose minimally in April. If you want to know why consumption has its limitations, consider the simple fact that spending power rose by less than 0.5% over the past year. If you don’t have the money to spend, you cannot spend unless you go into debt. Unfortunately for the average retailer, households have gone heavily into debt for homes and vehicles this past year and that may be limiting their ability to spend on everything else.
MARKETS AND FED POLICY IMPLICATIONS: Inflation may not be rising sharply and that is the one saving grace for this economy. With wage gains barely exceeding the moderate inflation rate, the potential for consumption growth is limited. Let’s not forget that tax cuts prime the pump but once it is primed, you still need to expand spending power. So you get a short-term bump to a higher level of demand but where do you go from there? It depends heavily on income growth adjusted for inflation. Spending power growth peaked in October 2015 and has decelerated sharply since then as inflation accelerated and wage gains didn’t keep pace. Real wages have grown by less than 1% per year, on average, for the past seven years and increased by over 2% only in 2015. Unless that changes, don’t expect consumers to spend at a pace that could lead to stronger economic growth. Investors might like these reports, but for the wrong reason. A more moderate inflation rate could be viewed as limiting the Fed’s animal instincts (i.e., their desire to normalize rates). But if the hope is that the economy will grow at 3% or more, well you can get it for a short time with a tax cut but it cannot be sustained without much more rapid real wage gains. And that could cut into earnings.