Retail Sales Weaker

Pipeline Inflation Heats Up

Retail sales slipped 0.1% in February as a downdraft in vehicle sales took a larger-than-expected toll. A delay in tax refunds until March likely exacerbated the weakness we saw in February sales. The data is seasonally adjusted to allow for a surge in spending associated with tax refunds that tends to show up in February. The data for January were also revised up slightly. Consumer spending has slowed substantially after surging during the holiday season. The extra boost to spending from building repairs and vehicle replacement following the devastating hurricanes and wildfires in late 2017 has largely played out.

The data for the month were mixed with a lot of negatives offset by a few large positives. Spending at building material and garden stores jumped 1.9% last month, reflecting the broader trend to repair and remodel. Existing homeowners are opting to remodel instead of trading up in a housing market that is tight in supply and rich in prices. First-time home buyers are being forced to invest more to bring their homes up to code. The challenge is finding contractors, who are also in short supply. It is notable that the increase in construction jobs in February was concentrated among specialty contractors who work on single-family homes instead of the large multifamily and commercial projects.

Online spending increased in February, while general merchandise stores, particularly traditional department stores, lost ground. Big-box discounters actually gained a little ground. The increase in online spending is a secular, permanent move as consumers rethink how and where they spend their money. There has also been a shift in big-ticket purchases such as furniture to online outlets. That may explain some of the broader weakness in furniture and appliance store sales despite anecdotal reports that they are gaining traction.

Spending at clothing stores rose. The increase, however, came on the heels of a sharp increase in apparel prices. After adjusting for inflation, spending on apparel actually declined, which suggests that discounting will return to this sector soon. We also saw a jump in spending at sporting goods and hobby stores.

Separately, the Producer Price Index (PPI) for final demand rose 0.2% after spiking 0.4% in January, slightly hotter than expected. The trend on pipeline inflation is much more pronounced. Total PPI has accelerated from a 2% year-over-year pace in February 2017 to a 2.8% pace in February 2018. The upward trend in the core measures for that index were a little more dramatic, with prices moving up from an annual pace of 1.8% one year ago to 2.7% today.

The bulk of those gains occurred in services, which are more susceptible to increases in wages and domestic demand than goods, which compete more directly with imports. The CPI data for the month was more benign than the data on producer prices. The question is when and whether those increases are passed along to consumers.

Federal Reserve officials will not be entirely pleased with this mix of data when they meet on March 20-21. While a rate hike is all but a foregone conclusion, inflation hawks will point to the trends in pipeline inflation and the move up in employment to justify the decision. I would not be surprised, however, if President Raphael Bostic of the Atlanta Federal Reserve Bank dissents. It will be the first time he is a voting member of the Federal Open Market Committee (FOMC), which sets rates. A dissent by Bostic would reflect the minority of Fed presidents who still oppose raising short-term interest rates.

Bottom Line
The economy has slowed during the first quarter of 2018 but not enough to derail the Fed's plans to continue raising rates. Recent employment gains and fiscal stimulus from new tax cuts and increased federal spending suggest that any slowdown in the headline numbers will be transitory.

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