KEY DATA: Sales: +0.2%; Less Vehicles: +0.1%/ CPI: +0.1%; Less Food and energy: +0.2%/ Real Earnings: -0.1%
IN A NUTSHELL: “Prices may not be rising sharply, but they are increasing enough to restrain purchasing power and household spending.”
WHAT IT MEANS: We are starting to get the first set of fourth quarter numbers and right now they are not anything to write home about. Retail sales rose modestly in October and much of the gain came from sales of vehicles. Until we know about the extent of the flood replacement purchases, the vehicle component has to be viewed with caution. Once the replacement process is over, demand could tumble. The spending report was a bit misleading. For some strange reason, sales on the Internet were actually down. Also, falling gasoline prices reduced sales in that component. Meanwhile, in addition to the strong vehicle demand, people spent a lot of money on clothing, sporting goods, health care and furniture. And, they ate like crazy as spending at restaurants and supermarkets jumped.
On the inflation front, consumer costs didn’t increase a whole lot in October. Declines in gasoline prices, clothing and new vehicles offset increases in shelter, medical and used vehicles prices. Food costs were down in almost every category, including cupcakes. The breadth of the decline was odd and needs to be watched. It could mean they will be up next month. Excluding food and energy, the so-called core index, household prices increase a little faster. Since October 2016, the overall Consumer Price Index is up 2.0% while the core rose 1.8%, both pretty much at the Fed’s target.
Despite the modest rise in prices, household spending power declined in October. Real earnings, which adjusts for inflation, fell as wages were flat. Over-the-year, they are up only 0.4%. Need I say it again? Yes. It is hard to sustain strong economic growth if households don’t have the money to spend and right now, they don’t. They are maintaining their consumption levels by reducing their savings pace and that is not good news for future growth.
MARKETS AND FED POLICY IMPLICATIONS: There simply is not enough information to determine if we will once again se a growth rate near or even above 3% in the fourth quarter. The consumer is going to have to do a lot better if growth is going to be strong in the final quarter of the year and there is little reason to be confident that will be the case. Wage gains are moribund, energy pressures continue to build and labor shortages point to modest job increases. The one good thing we have going is that there is now a worldwide expansion. Almost all regions of the global economy are actually in phase and growing. That should help exports. Businesses are likely to wait and see what the tax bill actually contains, especially since some of the tax breaks may be put off for a year. Investors are becoming more cautious about the tax plans as they keep changing. As for the Fed, there is every reason to think that another rate hike will occur at the December 12-13 meeting. The economy has enough strength that there is no reason to slow the normalization process.