KEY DATA: Retail Sales: -1.3%; Excluding Vehicles: -0.7%/ IP: +0.8%; Manufacturing: +0.9%; Vehicles: +6.7%/ PPI: +0.8%; Personal Consumption: +0.4%/ NAHB: -2 points
IN A NUTSHELL: “The consumer is spending, just not as rapidly, as prices continue to soar.”
WHAT IT MEANS: About once a month we get a data dump and today was one of those days. The big number was the retail sales report, which provides some insight into consumer behavior. Households cut back their spending pace in May sharply after spending like crazy in April. We knew that was going to happen as the April vehicle sales pace was not sustainable. But even excluding vehicles, demand fell sharply. The details, though, were really mixed. There were huge declines in purchases of furniture, electronics, building supplies and general merchandise. However, we bought lots more food, both at home and in restaurants, and sales of clothing, health care products and gasoline also rose. As for the internet, demand was down there as well.
Industrial output surged in May as the vehicle sector picked up the pace sharply. This sector has been constrained significantly by the shortage of chips and that supply problem remains a major concern. The production of both consumer goods, business equipment and technology products picked up significantly, indicating that demand is expanding across the entire economy.
The cost of production continues to rise dramatically. The Producer Price Index was up sharply in May and over-the-year, it has risen by 6.6%. But the details are not quite as distressing – or threatening. The costs of personal consumption products are not increasing as rapidly as the overall index and that points to high but not huge gains in consumer prices.
Housing activity eased a touch in early June. The National Association of Home Builders’ Index declined moderately, led by weakness in the Northeast and West. Still, the measure is indicating that the market is now only red hot instead of white hot. Whether that is due to a lack of demand or supply is not clear from these numbers, but all other indications are that it is an inventory issue. IMPLICATIONS:The Fed is starting its two-day meeting today and the latest data, when taken out of context, would look to be troubling. Consumer spending declined, the housing sector eased back, and business costs continue to soar. But those numbers don’t tell the whole story as consumption is still strong and housing remains robust. The rise in production is a clear sign that growth is not faltering. But for the monetary authorities, the one concern could be the continued surge in the cost of doing business. The members want to get the tapering process started and there is every reason to start sending messages that the economy not only doesn’t need any additional help, but could use a bit of moderation. However, I don’t think they have reached the point where they are willing to say that. It is not necessarily a fear of another taper tantrum and a market meltdown. I think the major concern for the Fed is the uncertainty about what happens when the government stimulus funds start to run out. We are several months away from that point and then it could take at least six months to see how things settle out.The Fed appears willing to accept excessively high inflation for an extended period because it believes inflation pressures are only transitory. The biggest problem with the sentence I just wrote is that no one has any idea what is meant by “extended period” and “transitory”. The Fed likes to use words and phrases that are like rice cakes: They seem to have substance but are all air. Those types of words provide flexibility and gives the members wiggle room. And until they see that inflation expectations are no longer well anchored, the members will argue they don’t have to do anything. So, I don’t expect much out of this meeting and tomorrow’s statement and press conference will not likely be that telling. What needs to be watched are the inflation numbers in the economic projections table. They were too low in the March report and how much they are raised will provide some insight into the concerns members have for future inflation.