Updated with more insights from report, analysts' comments and market reaction.
U.S. consumers defied the macro challenges and went about a spending spree in August. The number, however, is likely to matter very little for Wednesday’s Federal Reserve rate decision, as markets have largely priced in the expected move. Instead, investors are likely to focus on the Fed’s updated projections and Chair Kevin Warsh’s guidance on the path for rates from here.
Deciphering the August Print
A Census Bureau report released Wednesday showed that retail sales climbed 1.2% month over month (MoM) versus expectations for a 0.8% rise.
The August performance marks a rebound from the revised 0.5% drop (initially estimated as a 0.6% decline) for July.
Core retails that strips off autos climbed 1.4% (consensus +0.6%, reversing the revised 0.2% drop in the previous month. Retail control group sales, which is a tighter and a more refined subgroup that excludes autos, gasoline, building materials/garden equipment and food services, rose 1.4% (consensus +0.4%), reversing all of the 0.4% drop in July.
On a year-over-year (YoY) basis, retail sales climbed 6.01% compared to July's 5.1% increase.
What's Behind August Strength
The August rebound was broad-based rather than driven solely by autos or gasoline. Non-store retailers rose 2.6% from July and were up 9.9% from a year earlier, while sporting goods, hobby, musical instrument and book stores increased 1.2% on the month and 10.7% year over year. Miscellaneous retailers also posted a 1.9% monthly gain and 14% annual increase.
Spending at food services and drinking places rose 1.2% from July and 5.8% from a year earlier, while clothing stores gained 0.7% and general merchandise stores increased 0.7%. Electronics and appliance stores added 1.6%.
Gasoline sales also provided a significant boost in dollar terms, rising 3.1% from July and 21% from a year earlier, reflecting higher fuel prices. But the strength extended beyond gasoline: sales excluding motor vehicles and gasoline stations still climbed 1.2% in August and were up 5.6% year over year.
That makes the report notable for the Fed: consumer demand appears to have remained resilient even as higher energy costs and tighter financial conditions have clouded the outlook.
Analysts Laud Excellent Print
Chris Zaccarelli, Chief Investment Officer for Northlight Asset Management, termed the retail sales data as "excellent." The strategist attributed the strength to robust corporate profits which has helped overcome the twin headwinds of higher energy prices and rising bond yields. Zacccarelli now sees a 25bps hike later on Wednesday as a foregone conclusion.
“Given the current path of inflation, relative strength of the labor market and underlying resilience of the consumer, there isn’t any reason why the Fed won’t raise rates by 25 bps this afternoon.
LPL Chief Economist Jeffrey Roach also echoed similar sentiments. "Given the rebound in retail sales, we are on track for another quarter of solid corporate earnings. We also expect the Fed will raise rates to address the inflationary pressures coming from the demand side of the economy," the economist said.
The economist highlighted the robust control group sales as the metric directly feeds into GDP calculations. He expects real economic growth for the third quarter at 2.1%.
How Markets Reacted to Data
Equity stock futures held up despite giving back some of the gains after the data. The Nasdaq E-mini futures (NQ) and the E-mini S&P 500 futures (ES) were all solidly higher. The 10-year U.S. Treasury yield stayed just below the 5% threshold but the U.S. dollar Index (DXY) gained further ground, approaching the 100 psychological resistance.
MarketFramework's Positioning Edge tool suggests that the recent ES advance is being supported by the traders who have been on the wrong side of the market, with unprofitable participants holding a larger long bias (72.7%) than profitable traders (36.4%). This "strong bearish divergence" implies that the ES rally is increasingly being driven by traders who are positioned against the prevailing price trend, raising the risk that the advance could lose momentum if these unprofitable longs begin to unwind.
Retail Strength Takes Back Seat to Fed
The strong retail sales report comes hours before the rate decision that will likely smother any market reaction to the former print. While resilient consumer spending could reinforce the case for a restrictive stance, the rate decision and, more importantly, the Fed’s updated projections and Chair Kevin Warsh’s guidance are likely to dominate trading.
Click here to read what strategists expect from the September FOMC meeting.
With a 25-basis-point hike widely expected, markets will be looking for clues on whether the move marks a one-off adjustment or the beginning of a broader tightening cycle.
The energy price spike and climb in bond yields have clouded the macroeconomic outlook, putting the Fed in a bind as it seeks to balance its dual mandate of maximum employment and price stability.
