Stocks got off to a rocky start yesterday, keyed off a disappointing December retail sales report, but they managed to stage something of a recovery following more happy trade talk ending the day down 104 points versus an earlier 235 point intra-day loss. Treasuries, meanwhile, leapt from the starting gate after the abysmal retail sales numbers and never looked back. We talk more about the retail numbers below but suffice it to say they were so bad that some rebound in January and beyond seems likely. Regardless, the poor spending numbers put a serious dent in fourth quarter GDP estimates with the Atlanta Fed’s GDPNow model dropping its estimate from 2.6% to 1.5%. The report also adds more credence to the Fed’s dovish shift, and while a rebound is expected, the Bloomberg consensus for first quarter GDP is a mediocre 2.0%, not exactly a vigorous rebound.
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The January CPI report that was released on Wednesday, while generally matching expectations, did have enough whiffs of gathering inflation to put pressure on bonds in the post-release trade. Modest cost increases in service categories such as retail and leisure and hospitality supports the theory that wage increases are finally starting to appear in some categories that are having to deal with tight labor markets such as retailers, restaurants and bars. The thought that this is just the beginning of wage-generated cost pressures pushed short-end yields higher as a modest upward repricing of odds for a rate hike later in the year moved through the market.
That bit of upward pressure in yields, however, was reversed quickly and thoroughly yesterday as the shutdown-delayed December retail sales numbers were finally released and boy were they bad. The control group—which is a direct feed into GDP calculations— was down -1.7% for the month versus expectations of a 0.4% increase. That result was the biggest one-month drop since 2001. On a headline basis the series was down -1.2% versus 0.1% expected. Also more concerning was the breadth of the decline with spending increasing in only two of 13 categories (autos and building materials). We had been noting faltering consumer confidence readings, especially as investors suffered through a horrible December, but we were looking for concrete data that confirmed the consumer was stepping back after waning confidence. This report confirms that was indeed the case.
While retailers had already reported mixed-to-disappointing results during the holiday season this was the first report to confirm that it wasn’t a brand-specific issue but was more broad-based. The sluggishness could extend into this quarter with complaints already being heard about the size of tax refunds dropping versus last year, even with a full year of tax cuts in effect. Reduced withholding schedules are the prime culprit but the modest extra dollars in paychecks during the year obviously weren’t as impactful as the anticipated large tax refund check. Robust labor market gains should help stem any long-run consumer malaise but upcoming spending and confidence readings will certainly be closely scrutinized. Later this morning we get the preliminary read on confidence from the University of Michigan with a small bounce expected from 91.2 to 93.7. This compares to a high reading of 101.4 in March 2018. So a bit of a rebound is expected but well off the highs from early last year when tax cut euphoria was strong.
Some offsets to the weak retail sales report are that the numbers are reported in nominal dollars so the drop in gas prices and lower priced imports—thanks to the strong dollar-probably exacerbated the extent of the declines. So while the consumer unequivocally pulled back the purse strings in December, the price deflation that occurred during the month no doubt goosed some of the negative month-over-month results. Plus, the numbers were so bad some are panning the report as flawed, perhaps a victim of questionable measurement given the shutdown-induced delay.
We’d be remiss if we didn’t point out another item that caught our eye this week. As noted earlier, auto sales were one of the two categories that did experience gains. But all is not well in that segment either. While mortgage loan originations fell in the fourth quarter versus the third, and for the year were the lowest since 2014, auto loans saw the highest volume ever in 2018 ($584 billion). Unfortunately, 7 million Americans are at least 90 days past due on those loans, the highest number in history. In fact, there are more people with late loan payments than there were at the height of the Great Recession. The category with the largest delinquencies are predictably sub-prime borrowers. Apparently the sub-prime cohort pulled back from the mortgage market but they have apparently been active in buying expensive new cars.
While the first quarter has historically been the softest of the bunch, and this one is shaping up to follow suit, there are plenty of other indicators that imply the December weakness bleeding into the first quarter is likely to be temporary. Labor market strength is one big factor along with equity markets rebounding so far in 2019; thus, consumer confidence is likely to bounce from the late-2018 dip. In all, the combination of retail sales and CPI confirms that the Fed was correct to hit the pause button for the first-half of 2019, but if consumer confidence and spending rebound after the late-year weakness, the Fed’s rate-hiking patience may get tested.
Germany's Sudden GDP Drop
Germany reported fourth-quarter GDP yesterday and they barely avoided recession. The largest economy in Europe posted a flat fourth-quarter GDP and that followed a –0.2% print in the third quarter. The Eurozone as a whole posted fourth-quarter GDP of 0.2% and 1.2% for the full year. The slowdown hit the Continent in the second half of the year as Brexit negotiations staggered towards a finish and U.S. tariff threats on German-made cars undermined spending and confidence. The gathering slowdown in Europe adds weight to the troubles in Japan and China and presents an increasing headwind to the US economy.