Pivot to Services Underway in May

Retail sales dropped 1.3% in May after sharp upward revisions to April sales. We are still on track to see double-digit gains for the second quarter after adjusting for inflation.

The slowdown in retail sales was driven by the sharp drop in vehicle sales and everything related to housing. Demand cooled as consumers, deterred by higher prices, shifted their focus to stepping out at restaurants and bars. Supply constraints due to computer chip shortages persisted; plants are still trying to ramp up.

The control for retail sales, which strips out the volatile vehicle and gasoline station components and feeds directly into GDP calculations, fell 0.7% during May, following upward revisions to April. Spending online dropped as consumers chose instant gratification instead of waiting for delivery. Spending on furniture, electronics, appliances and exercise equipment all declined. We are shifting from making our homes more liveable during quarantine to escaping the confines of our homes for the first time in nearly a year.

Spending at department stores and specialty retailers rose 3% as shoppers snapped up clothing, shoes and makeup to see and be seen. Health and beauty stores posted a second month of solid gains. A casual walk through my local mall and conversations with store clerks revealed that new merchandise is flying off the shelves. The travel aisle at my local drugstore was sold out; even the shelves for lipsticks were stripped clean.

One of the most striking aspects of this retail sales report is the surge in spending at restaurants and bars, which is now 1.3% above the pre-pandemic level hit in February 2020 after adjusting for inflation. The problem is that those gains are concentrated in larger chains that can better afford wage hikes to attract workers than smaller restaurants and bars can.

This is at the same time that employment in food services and drinking establishments is down a staggering 1.5 million from the peak in February 2020. Large chains are better at leveraging technology to cushion the blow of higher wages on profit margins; they are eliminating some jobs entirely as they gain market share. Fast-food behemoths are automating orders and pay to speed drive-through and pickup orders. The shift allows a step up in wages and benefits now, but ultimately could concentrate more employment at large firms and undermine worker leverage down the road.

The surge in leisure travel during May is not reflected in the retail sales data; it will show up with the release of overall consumer spending later in the month. Surging prices for airfares and hotel rooms, and the crowd in Las Vegas Memorial Day weekend, point to higher spending.

Separately, the producer price index (PPI) for finished goods surged 0.8% in May and jumped 6.6% from a year ago. That is well above the surge in the consumer price index (CPI) for the month and the year in May. That marked the strongest gains for the index since the methodology was changed in 2010. The largest PPI gains were in metals, inputs for farming, beef, veal and vehicles. Look for increases in vehicle costs, which have been a primary driver of overall inflation, to abate as demand cools and production lost to supply chain disruptions is recouped later this year. Service sector prices also posted increases, notably in the margins on services at auto dealers, which jumped 27.3% alone; a lot of that is in the margins selling used vehicles.

Look for pricing pressures to shift from goods to the service sector along with demand in the months to come. It looks like we are in for a hot summer. Pricing pressures are expected to cool as we move into 2022 when the heat upon reentry dissipates with a replenishing of goods inventories. Pent-up demand in services is different than that for goods; we can’t recoup haircuts lost to the pandemic, but we can now splurge on a broad spectrum of salon services. Wage pressure should abate, sadly at the expense of smaller restaurants and retailers, as we move into 2022 and more of that employment is concentrated in larger corporations.

Bottom Line
High prices on vehicles and homes are accelerating the shift away from spending on big-ticket items to fill our homes and garages to spending on services. Consumers are escaping their homes, stepping up and stepping out. They are highlighting their smiles after vaccinations that have allowed them to set aside their pandemic masks.

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