Strong sales report may delay rate cuts

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Consumers have put a crimp in expectations for rate cuts this year.

Retail sales rose 0.5% in May, with broad-based increases — 11 of the 13 major retail categories posted gains — the Commerce Department reported Friday. Although sales missed the 0.6% rise expected by economists polled by IFR Markets, the numbers for March and April were revised higher, showing strength. Consumer spending is a major driver of gross domestic product.

With the Federal Open Market Committee meeting June 18 and 19, markets have priced in rate cuts later this year after Fed leaders said policy makers would “act as appropriate to sustain the expansion.” Investors are looking at Wednesday’s release of the Summary of Economic Projections and Chair Jerome Powell’s post-meeting press conference for hints of a more definite timeline and plan.

The spending numbers suggests GDP may remain stronger than expected and could impel the Fed to discount a weak nonfarm payrolls report and low inflation for a little longer.

The Federal Reserve Bank of New York raised its GDP estimates to 1.36% for the second quarter, after a 1.01% estimate last week, and to 1.70% for the third quarter from 1.31% last week.

Separately, consumer sentiment slipped, according to the University of Michigan’s preliminary June index. Sentiment declined to a still-robust 97.9 from May’s final 100.0 read, while current conditions rose to 112.5 from 110.0 and expectations slid to 88.6 from 93.5.

The five-year inflation outlook dropped to 2.2%, its lowest level in survey history, from 2.6% last month, while the one-year inflation outlook fell to 2.6% from 2.9%.

“Although consumer sentiment dropped in June, it remains quite elevated and is one of the driving forces (in addition to low unemployment, declining interest rates, solid real earnings growth) behind our expectation for sustained healthy consumption growth,” said Berenberg Capital Markets U.S. Economist Roiana Reid.

Industrial production
Industrial production grew 0.4% in May reversing a 0.4% decline in April, while manufacturing output was up 0.2%, the first time it increased this year. Capacity utilization rose to 78.1% from 77.9%, the Federal Reserve said.

“Note that, although overall production increased, the most important component of that report that reliably gauges underlying manufacturing demand — manufacturing production excluding motor vehicles — was flat in May,” Reed said. “Moreover, overall production is still below the December peak. We are stuck in an industrial slump.”

The indicators suggest “a continued divergence between the consumer and business sectors,” she said. “Our forecast for sustained economic growth amid the U.S. and global industrial slump, sluggish business fixed investment and softening exports, is dependent on healthy sustained growth in consumption. Consumers are rising to the challenge thus far.”

Business inventories
U.S. business inventories gained 0.5% in April, after a flat reading in March. Sales were off 0.2% in the month after a 1.3% increase in March.

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