Retail sales dropped 0.2% in May from April and were revised from a slight positive to a decline in April. Some of the largest declines occurred in building materials and garden equipment stores, and at gasoline stations. The drop at building and garden stores was to be expected, given the surge we saw in spending at those stores last winter when temperatures were unseasonably mild. The drop in spending at gasoline stations was more related to a welcome drop in prices at the pump. Unfortunately, those declines didn’t translate into much in terms of additional discretionary spending, as consumers cut back on spending at restaurants and bars. We also saw some pullback in spending at health and personal care stores, reflecting a larger pullback by consumers on health care consumption. Many cash-strapped consumers have either cut back on their prescriptions and/or their visits to doctors. Moreover, when they do go, they often fail to pay the co-pay on those visits, leaving the healthcare provider with a bulge in uncollected receivables.
The only bright spot in the retail sales report was vehicle sales. Most producers continue to complain that sales remain constrained from where they thought they would be by now, as consumers replace vehicles that are too old to repair anymore, but not much of a cyclical increase in demand. Indeed, used vehicles have gone up in price fairly sharply over the last year, as people are hanging onto their existing vehicles so much longer than they did in the past.
Separately, the producer price index (PPI) plummeted a larger-than-expected 1.0% in May, mostly on a 4.3% drop in energy prices. (Prices at the pump dropped a whopping 8.9 %.) Prices for finished foods also moved down a bit, further alleviating the commodity-based inflation we saw earlier in the year. The core PPI (non-food and energy) rose a modest 0.2%, which was almost entirely due to a jump in the cost of preparing pharmaceuticals. This is unlikely to be passed on, as much higher inflation for prescription drugs, given the pullback we have seen on spending in that arena.
Bottom Line: The pattern of weakness that we saw emerge in early spring continues, with constraints on employment showing up in constraints on spending and inflation. This will open the door a crack for additional action at the Federal Open Market Committee (FOMC) meeting next week. The lowest-hanging fruit seems to be an extension in the Federal Reserve’s current program to reinvest short-term treasuries and maturing mortgage-backed securities(MBS). Refinancing, in particular, has picked up, which will drain the Fed’s balance sheet of MBS, something those looking to maintain the Fed’s current policy of easing will want to counteract. The Fed will likely disappoint markets and keep its powder dry on QE3 or a large scale expansion in its balance sheet, until we see a more substantive weakening in overall economic conditions, most likely emulating from Europe.