TLT - Retail Sales Supports Soft Landing Expectations But Delayed Rate Cuts

2023-12-14 11:20:10 ET

Summary

• The Advance Retail Sales Report for November 2023 has been published, providing initial data on consumer spending at U.S. retail establishments.  Sales were stronger than expected.
• Retail sales in November grew at an above-average pace -- particularly in real terms -- reflecting deflation in goods categories and indicating strong consumer spending and overall economic growth.
• Deflation in prices of retail goods was notable.

The Advance Report on Monthly Sales for Retail & Food Services, corresponding to activity during the month of November 2023, was published by the Census Bureau at 8:30 AM, December 14, 2023. This report – widely considered to offer some of the best and most timely high-frequency indicators of current U.S. economic activity – provides initial data on consumer spending at U.S. retail establishments during the reference month. In this article, we walk our readers through an in-depth analysis of this just-released data on retail sales and then discuss their implications for the U.S. economy and financial asset prices.

Summary Data and Analysis

We begin our analysis of the Advance Retail Sales Report by reviewing summary information highlighted in Figure 1. We recommend that readers pay particular attention to the percent rank of Month-on-Month (MoM) growth, MoM acceleration, and the surprises relative to forecasts.

Figure 1: Change, Acceleration, Expectations, and Surprise

The “Advance” sample of Retail Sales (Retail Trade & Food Services), totaled $705,692 million (seasonally adjusted) during the month of September, compared to the prior month’s $703,748 million (revised up from $704,954 million), representing a Month-on-Month (MoM) growth rate of 0.28%, which ranks in the 44th percentile. This MoM growth rate represents an acceleration of 0.50% versus last month’s -0.22% (revised up from -0.11%). November growth was greater than the median forecast of -0.10%.

The Impact of Inflation on the Value of Retail Sales

In this section, we highlight the impact of inflation on the interpretation of Retail Sales data. Price inflation impacts the quantity of goods and/or services that a given amount of money can buy. In order to track the actual quantity (as opposed to mere dollar value) of goods that retailers sell, it is necessary to adjust the nominal sales figures (reported in “current dollars”) for the impact of inflation. In Figure 2, we show Retail Sales in both “current dollars” and in “real” terms. The “real” figures represent the economic value of goods sold by retailers, after they have been adjusted for inflation in specific retail goods/services categories.

Figure 2: Real Sales in Current Dollars and Adjusted for Inflation

In nominal terms, Retail Sales accelerated, however, in current dollars Retail Sales’ acceleration was stronger (0.67%). It should also be noted that the MoM retail sales inflation was actually below the Fed’s overall target – actually deflating. This should be highlighted as a positive development in this report, which will boost GDP growth estimates for the fourth quarter of 2023.

For the remainder of this article, all figures will be presented in “real” (inflation-adjusted) terms. This is important because the most important indicators of economic activity in the U.S. economy, such as Real Gross Domestic Product and Real Gross Domestic Output, are accounted for in real-inflation adjusted terms.

Analysis of Annualized Growth of Key Components of Retail Sales Over Various Time Periods

In this section we break down Retail Sales into key components, scrutinizing their annualized growth rates over various time frames (1m, 3m, 6m and 12m). The purpose of this analysis is two-fold. Our first purpose is to identify which components of retail sales are growing at a faster or slower rate than the overall aggregates. Our second purpose is to determine whether, and to what extent, growth rates are accelerating or decelerating over various time frames.

Figure 3: Real Annualized Growth Rates of Key Components

During the latest 1-month period, the real growth rate of overall Retail Trade & Food Services sales was significantly above the historical median (70.94 percentile). This rate of growth was similar to that exhibited over the most recent 3-month and 12-month period. Drilling down further into the real growth rate data, the breadth was good, with both the Control Group and Ex-Control Group categories exhibiting above-average growth. The November data reflect some more dispersion in growth rates between categories than we have generally seen in recent months. However, the divergences are not significant enough to provide signals regarding potential acceleration or deceleration going forward.

Key Drivers of Change and Acceleration: Decomposition Analysis

In this section, the analysis is focused on identifying which components of retail sales are driving the MoM growth (contraction) and MoM acceleration (deceleration) in the overall Retail Sales figures. We develop this analysis in three steps. First, we analyze the contributions of the Control Group and the Ex-Control Group to the reported overall MoM growth and acceleration of Retail Sales. Second, we focus exclusively on the Control Group and break down the component contributions to its reported MoM growth. Third, perform the same analysis for the Ex-Control Group.

Contributions to Change and Acceleration from Control Group & Ex-Control Group

In this subsection we focus on the contributions of the Control Group and Ex-Control Group to the MoM growth and MoM acceleration of Retail Sales.

Figure 4: Control Group & Ex-Control Group Contributions to MoM Retail Sales Growth

Both the Retail Control Group and the Ex-Retail Control Group accelerated in real terms, with the Retail Control Group contributing slightly more to both the total change and the total acceleration of Retail Sales.

Control Group: Analysis of Component Contributions

In this subsection we focus the component contributions to the MoM Change and MoM Acceleration of the Control Group.

The Retail Sales Control Group excludes spending on automobiles, gasoline, building materials, and food services. By removing these volatile and/or otherwise unrepresentative components, the Control Group typically provides a better indication of underlying trends and tendencies in consumer spending.

Figure 5: Control Group: Contributions of Components to Change and Acceleration

The largest positive contributor to Retail Control Group’s acceleration was by far Non-store Retailers (0.46%) followed up by Clothing and Clothing Accessory Stores (0.16%). The largest contributors to deceleration were Miscellaneous Store Retailers (-0.11%) and Health and Personal Care Stores (-0.06%).

Ex-Control Group: Analysis of Component Contributions

In this subsection we focus the component contributions to the MoM Change and MoM Acceleration of the Control Group.

The Ex-Control Group consists of sales by retail vendors in four major categories: Motor Vehicles and Parts, Building Materials & Gardening Equipment, Gasoline Stations and Food Services & Drinks. Monthly growth in these categories often tend to be volatile and/or otherwise unrepresentative of overall trends and tendencies in consumer spending. Therefore, monthly Ex–Control Group sales growth numbers need to be analyzed in an appropriate context. However, taken as a group, it is important to note that the overall incidence of Ex-Control Group sales is important, representing 41.78% of total Retail Sales for this month.

Figure 6: Ex-Control Group: Contributions of Components to Change and Acceleration

The growth and acceleration in the Ex-Control Group was driven by Motor Vehicle and Parts Dealers (0.31%) and Food Services and Drinking Places (0.28%). While Gasoline Stations (-0.14%) and Building Mat. and Garden Equip. and Supplies Dealers (-0.06%) contributed to deceleration.

Implications for the U.S. Economy

Retail Sales is one of the most important indicators of current economic activity in the U.S. Overall Real Retail Sales in November grew at an above-average pace, surpassing the median forecast of professional economists. Looking deeper, our detailed analysis shows that the data were particularly strong in real (inflation-adjusted terms), reflecting the deflation in goods categories reported in the most recent CPI report.

Today’s retail sales report indicates that the U.S. consumer has remained remarkably strong despite numerous headwinds. This report strengthens the impression that consumer spending, and the overall U.S. economy, is still growing quite strongly, despite the Fed’s attempts to engineer a slow-down. Indeed, the report is supportive of expectations of a “soft landing” for the U.S. economy.

Implications for Financial Markets

The effects that retail sales data can have on financial markets are complex, and a number of factors must be taken into account. One major factor to consider is what expectations were prior to the report. A second factor to consider is whether the overall economy is perceived to be running “hot” or “cold.” A third set of factors is non-fundamental, such as technical conditions, sentiment and positioning. Keeping all of this in mind, let us separately consider how today’s retail sales numbers could potentially impact fixed income and equity markets.

Fixed income markets (interest rates, bond prices & bond yields). The first thing we will consider is that, overall, the retail sales data were significantly stronger than expected. All things equal, “hotter-than-expected” data typically leads to lower bond prices and higher bond yields. A second factor to consider is that the retail sales data this month tends to indicate above-trend growth in real consumer spending. Such an environment is typically supportive of lower bond prices and rising bond yields. The final set of factors we will consider is non-fundamental: in our view, prior to the release of the retail sales report, technical conditions had become overbought after the furious rally off of multi-year lows (multi-year highs in yields) in Treasury markets.

Taking all of the above factors into account, we would expect Treasury yields to rise in the wake of this report. In particular, markets may begin to price in lower probabilities of rate cuts by the U.S. Fed. The Fed wants to be seeing below-average growth rather than above-average growth in economic activity generally, and retail sales specifically.

Common equity markets. Equity markets tend to react differently than bond markets to retail sales data. First, positive surprises in retail sales data and/or above-average growth in retail sales tend to be supportive of improving expectations for growth in corporate revenues and profits. All else equal (which it never is), the sort of above-average growth that we say in November would ordinarily tend to be supportive of rising equity prices. Second, in contrast to the aforementioned consideration, to the extent that above-average retail sales growth is considered to be indicative of economic conditions that are “too hot,” equity prices may tend to fall if it is widely perceived that such conditions will result in higher wage and/or materials costs and/or higher interest rates. As indicated in the section on implications for bond markets, all else being equal, equity prices might be expected to fall due to the perception that growth in retail sales are stronger than expected. Third, in examining non-fundamental factors such as technical conditions, it is our view that after a strong rally off of recent lows, short-term sentiment and positioning were getting extended heading into today’s retail sales report.

Thus, taking all of these factors into consideration, the implications of today's report for equities are mixed. The surprisingly “hot” retail sales report will tend to lower implied probabilities in the timing of Fed interest rate cuts, which is generally a negative factor in the pricing of common equities. However, the strength of retail sales, particularly in real (inflation-adjusted) terms, supports expectations of a soft landing. A final consideration is that this report reflects significant deflation in retail goods -- to a greater extent than many market participants were probably aware. This is quite bullish for both bonds and equities.

Concluding Thoughts

At our Investing Group, we have been bullish on long-term Treasury Bonds and TIPS. However, we think that the strength of retail sales should give pause to highly optimistic expectations regarding interest rate cuts. Prior to this report the market was pricing in a 60%+ probability that the Fed would cut interest rates at the March 2024 meeting. The probability of a cut in March actually increased to 70% after this report.

It is our view that such Fed rate cuts will not probably occur until the second half of 2024, unless economic growth slows, the unemployment rate rises and CPI core services ex housing declines substantially. As such, the bond market may need to adjust, and we have become tactically cautious about long-term bonds. The fundamental environment for equities has improved, as the probability of a soft landing has increased. This is particularly bullish for cyclical sectors. However, our view is that the S&P VIX Index (VIX) is far too low relative to risk.

A nuanced portfolio strategy is needed to thrive in this environment.

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