May Retail Sales, Import and Export Prices and Weekly Jobless Claims

KEY DATA: Retail Sales: +0.8%; Ex-Vehicles: +0.9%/ Import Prices: +0.6%; Nonfuel: +0.2%; Export Prices: +0.6%; Farm: +1.6%; Claims: -4,000

IN A NUTSHELL: “Strong consumer demand and higher prices, perfect (or not) together.”

WHAT IT MEANS: How good is the economy? Very. Retail sales rose strongly in May. Even if you remove vehicles or gasoline or any of the other categories that can be volatile or are heavily impacted by price changes, this was still a really good report. Indeed, the numbers were so good that even department store sales surged! Only two categories, furniture and sporting goods, were down. Furniture demand was strong in April, weak in May but decent over the year. As for sporting goods, sales have been soft all year. I guess kids just don’t play outside anymore. And most impressively, the increase in retail sales was robust despite soft online demand. That is not likely to continue.

On the inflation front, conditions are heating up as well. Import prices surged in May, led by a jump in energy costs. Excluding energy, the cost of imported products rose more moderately. Consumer goods prices are not rising sharply, but the increases over the year have been consistently accelerating and have turned positive after being negative for several years. Imported food prices also increased. This is important because food has been a stabilizing factor in the consumer inflation measures. On the export side, the agricultural sector has been able to push through a lot of price hikes this year. This is again a concern if countervailing tariffs hit this sector, as has been threatened.

That the labor market is tight is hardly in doubt and the decline in jobless claims reinforces the view that the unemployment rate is heading downward.

MARKETS AND FED POLICY IMPLICATIONS: The Fed raised the funds rate yesterday and made it clear they are going up more this year and next. But there is every reason to think the projections in yesterday’s report will be the lower, not the upper bound of the rate hikes. As I have noted many times, we are in the midst of a Great Experiment: Can the economy survive massive tax cuts and huge government spending increases when it is already growing solidly and the labor market is at or near full-employment? The concern is that inflation will accelerate sharply because growth could become too strong. Yes, as I like to say, there is no such thing as a free robust economy. Right now, few economists really have a good handle on how to forecast inflation. Wages are simply not behaving as most models expected. The extensive nature of global trade has helped keep down both wages and prices. But tariffs add to the possibility that inflation will be higher than expected. The economic data are great, but can the growth be sustained if price gains move well above the Fed’s 2% target, forcing the FOMC to hike the funds rate more than currently projected? I think that outcome has a higher probability than the one where inflation is restrained and the Fed raises rates moderately.