KEY DATA: Sales: -0.3%; Excluding Vehicles: 0%/ CPI: +0.5%; Less Food and Energy: +0.3%/ Real Earnings (Monthly): -0.2%; Over-Year: +0.8%

IN A NUTSHELL: “In January, consumption cooled but prices heated up, which is not a good combination.”

WHAT IT MEANS: Did the consumer go on vacation? Are households waiting for their paychecks to increase as a result of the tax cuts before they start spending? I don’t know, but the decline in retail sales in January was the largest drop in nearly a year. We knew the number was not going to be great because vehicles sales were off, but this was well below expectations. And the decline in sales is actually worse than the headline number would have you believe. Gasoline purchases soared, but that was driven by a sharp rise in gasoline prices. Shoppers did buy more clothing, but that was about it.

In the “no good economy goes unpunished” category, the Consumer Prices Index jumped in January, led by the surge in energy costs. But even excluding energy, prices still rose solidly. The higher fuel prices drove up transportation expenses. Food and shelter prices rose moderately, but eating out cost a lot more. There was also an outsized surge in apparel prices, which happens periodically. Clothing costs are still down solidly over the year. As for health care, the spotlight on medical goods price increases may be working at they fell but medical services costs rose sharply. But maybe most importantly, consumer prices are up by 2.1% since January 2017, a touch over the Fed’s 2% target. Excluding food and energy, the so-called “core” index has risen 1.8%. The Fed prefers a different inflation measure, the Personal Consumption Expenditure (PCE) deflator, and that index could be close to the magic 2% pace when the data are release in a couple of weeks.

Consumer spending power continues to go nowhere as real, or inflation-adjusted wages dropped again in January. For the entire year, workers compensation rose modestly. Actually, the data are even more disappointing when you remove supervisory employees from the numbers. Real hourly wages were essentially flat over the year and even with hours worked up a touch, the weekly income increase was limited.

MARKETS AND FED POLICY IMPLICATIONS: The initial thought is that is that consumers must have been all tapped out from their holiday shopping, which explains the weak spending to start to the year. That would be nice if it were true. Retail sales were flat in December, which means there were two consecutive months of soft demand. The reason may be simple: Labor compensation continues to go nowhere. Once again, let me repeat that it is difficult to get strong overall economic growth without strong consumer spending. To maintain solid demand, households need the income to spend. They just don’t have it. As a result, as I keep harping on, the savings rate is near record lows. That might force families to use some of the tax cuts to rebuild household balance sheets rather than purchasing new goods. And then there is inflation. Reality seems to be setting in that the days of low inflation and therefore low interest rates are likely over. It appears we are moving back toward more normal levels of inflation and that is driving the increases in rates, also toward more normal levels. We will get the February CPI and the January PCE reports before the next FOMC meeting, which will be held on March 20-21. If the inflation pressures don’t turn around, it is likely that Chair Powell will raise rates.