KEY DATA: Sales: +5.3%; Department Stores: +23.5%: Restaurants: +6.9%; Internet: +11%/ IP: +0.9%; /Manufacturing: +1%/ PPI: +1.3%; Energy: +5.1%/ NAHB: +1 point
IN A NUTSHELL: “The economy picked up steam in January and inflation came along for the ride.”
WHAT IT MEANS: Remember all those warnings about the economy potentially slowing starting early this year? Well, never mind. Retail sales exploded in January as every major component was up. Indeed, the smallest rise was in supermarkets, which posted a “meager” 2.4% increase. In a normal month, that would be a surge. Furniture and electronics and appliances store sales rose double-digits and people ate out like crazy. There were some relaxing of restrictions, so I can actually understand the restaurant rise. But department store demand surging by over twenty percent? Really? I am just not sure what to make of some of these numbers.
Industrial production rose solidly in January as the manufacturing sector continues its recovery. That shows that the improvement is extremely broadly-based. If it weren’t for a cut back in vehicle assemblies, the increase would have been even bigger. And that slowing in production occurred despite a rise in sales, so look for vehicle production to bounce back once the parts situation is remedied.
Everyone seems to be talking about inflation these days and the jump in producer costs may be a reason why. The Producer Price Index rose sharply in January and not all of it came from increasing energy prices. Services costs jumped almost as much as goods prices. Just about every major and minor category posted a rise and those tended to be pretty solid. The collapse in price brought on by the shutdowns have been wiped out and producer costs are pretty much back to rising at the same pace they were before the pandemic.
The housing market remains rock solid. The National Association of Home Builders’ index rose in February after having come down fairly sharply in December and January from its November peak. Traffic picked up a touch, but future sales faded. Still, the levels of all the sub-indices continue to be extraordinarily high. IMPLICATIONS:The only logical explanation for the amazing retail sales numbers is that the second round of stimulus hit and was spent almost immediately. That is possible, as some people did run out of income due to the politics in Washington. But many may have had to reapply and that means we could see continued strong consumer purchases. The improvement in the manufacturing sector follows the rise in consumer demand and reinforces the view that as long as government funding flows freely and at a high rate, the economy can continue to recover.The December stimulus bill gets us largely through March and that is the target for the next round. Since President Biden is intent on getting a major bill through, look for that to happen and for government money to continue to get into the hands of households and businesses. And that raises questions about inflation: Is it going to rise (yes) and if so, what does that mean for Fed policy (not much)? The real question facing the bond and equity markets is will inflation pressures force the Fed to make a move earlier than expected. First of all, as I note just about every month, the pathway from producer prices is winding and usually does not end up where people think it does. That is, except for a few categories such as food, changes in wholesale costs don’t foretell changes in consumer prices.The inflation pressures, if they arise on a sustained basis, would likely come from retailers, seeing a chance to make up for lost income, raising prices. Forget the idea that companies will try to maximize sales by keeping prices low. If they have a chance to increase income by pushing up prices, I expect that they will. Over the past couple of decades, there have been few periods where firms have had pricing power, and this just might be one of them. But Fed Chair Powell has made it clear that the Fed is willing to run hot for an extended period, which means the real questions are: What is hot and how long is extended. My view is that if inflation remains below 3.5%, the Fed will not make a move for at least eighteen to twenty-four months. If it remains near or below 3%, the Fed doesn’t have to do anything until it nears its unemployment target. That could take a very, very long time. So, while longer-term rates are rising, that is not necessarily a sign of inflation fears. Did anyone really think a 10-year note somewhere around 1% made any sense when the Fed was making it clear that they wanted to get inflation to average 2%, especially given how long inflation was below 2%? The 10-year note is still way below where it will be once inflation gets to where the Fed wants it, so don’t be surprised if rates rise steadily for as long as the Fed is willing to run hot.That is, a long time.