KEY DATA: Sales: +0.6%; Excluding Vehicles: +0.4%/ Imports: -0.9%; Nonfuel: -0.3%; Exports: -0.2%; Farm: +0.8%/ Claims: +5,000
IN A NUTSHELL: “With consumers spending and the labor market really tight, the only thing that could keep the Fed from raising rates is the weakness in prices.”
WHAT IT MEANS: If all the Fed worried about was the domestic economy, there would be no worries at all. Retail sales were strong in July, led by robust vehicle demand. There were also decent gains for firms that sold furniture, building supplies, health care products, sporting goods, clothing and gasoline. The gasoline sales rise occurred despite a modest price decline, indicating people are driving more. People also ate out more and shopped online heavily. However, electronic and appliance purchases were off and people didn’t do much buying at department stores. So-called “core” sales, which better mirror the GDP consumption number, were up a solid 0.3%. There was also a sharp upward revision to June retail activity. Second quarter consumption looks like it was better than initially believed.
As for the labor market, the rise in unemployment claims was really modest. More importantly, the level remains extremely low, implying that firms are simply not laying off workers.
While the economy and labor markets are strong, the Fed’s other mandate, inflation, looks like it is not going in the right direction. It may seem strange that the Fed wants higher inflation, but that is because it is well below its target. The July import price report indicates inflation pressures are limited. Declining energy costs played a role in the fall in import costs but there was also a drop in consumer and capital goods prices. Vehicle costs were stable. Export prices fell, but the reeling farm sector was able to push through some price increases.
MARKETS AND FED POLICY IMPLICATIONS: The economy is strong enough to absorb a rate hike, especially since the increase is expected to be modest. Why anyone thinks a quarter point rise in short-term interest rates would hurt the economy is beyond my understanding. But there is inflation, which the Fed continues to argue will get back to normal rates over the next year or two. The Chinese currency devaluation should put downward pressure on prices. Let’s face it, the Chinese want to dump cheap goods onto the U.S. market to keep their economy from failing. The U.S. consumer is the target in this trade war. It is uncertain, though, who is hurt by the Chinese actions. U.S. consumers get lower cost goods but that might displace goods made in either the U.S. or other countries. To the extent that the Chinese action hurts other countries that export to the U.S., those countries will depreciate their currencies so they can remain competitive. But domestic firms cannot change their currency so there is a possibility of slower U.S. growth. Will the Fed put off raising rates because the Chinese action may lower inflation? I said this before and I will say it again: If the Fed doesn’t hike rates because the dollar may rise in value because of currency manipulation, the message sent is that the Fed can also be manipulated.