Rising Prices Boost Spending

Retail sales surged 3.5% in January after dropping a downwardly revised 2.5% in December. A pickup in vehicle, furniture and appliance deliveries, which were backlogged since last summer due to chip shortages, boosted spending. Vehicle sales surged 5.7% during the month but were actually down slightly after adjusting for the year-on-year gain in prices. New vehicle prices surged 12.2% from a year ago in January, the fastest pace on record. That includes the stagflation episode of the mid-1970s.

Chip shortages remain a problem and could set vehicle sales back again in February. Some plants were idled again in January due to chip shortages. This is in addition to disruptions triggered by protests at the Canadian border over vaccine mandates. Border trade is clear now; much of it is heavily skewed toward parts and vehicles.

Spending at building material stores, online and at grocery stores posted spectacular gains as consumers pivoted back into goods and online during the Omicon wave. The only weak spots were spending at gasoline stores and restaurants and bars, as travel and tourism slowed during the month.

Core retail sales, which feed directly into the consumption data for GDP, jumped 4.8% after falling 4% in December. Core retail sales are up 8.9% from a year ago, which is less than 2% after adjusting for inflation. Growth is slowing, despite the strong read on January retail sales, but only because of the ebb and flow of deliveries. Demand remains strong. Spending at traditional department stores took the lion’s share of business with a gain of 9.2% during the month after contracting 7% during the height of the holiday season in December. Real GDP now looks like it rose at a 2% pace in the first quarter, less than one-third of the red-hot pace of the fourth quarter.

The Federal Reserve views variants as more inflationary than disinflationary. Today’s retail sales data affirm that view. Consumers pivoted back into goods from services as Omicron spread. Some of the backlogs are easing but we are still a long way from being fully stocked with inventories. Vehicle producers do not believe those stocks will resemble anything normal until 2023.

The forecast for a one-half percent increase in the fed funds rate after the Fed’s next meeting in mid-March is all but a formality. The next step is when and how fast the Federal Reserve plans to let its bloated balance sheet shrink; that is more complicated and will be hotly debated at the March meeting. We could even see a dissent by at least one voting member in March - St. Louis Fed President Jim Bullard - who has been arguing for more aggressive moves by the Fed.

Regional Federal Reserve Bank Presidents Loretta Mester and Esther George have argued that sales of the Fed’s mortgage-backed securities holdings could be on the table. That would break with the Fed’s tradition of holding the assets it has acquired to maturity and would no doubt accelerate the removal of accommodative credit conditions.

Bottom Line
Shortages and the pace with which people can get what they want are playing a larger role than weak demand in determining retail sales. This is showing up as upward pressure on a broadening spectrum of prices and has left the Federal Reserve playing catch up with rate hikes.

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