Retail sales and producer inflation fell in February

  Retail sales dropped in February after surging in January, while producer inflation fell unexpectedly on the month, signaling easing demand pressures. Still, looking underneath the top-line numbers and through seasonal fluctuations, spending at retail stores remained solid. Wednesday’s data should give the Federal Reserve some relief as it faces a tough decision next week, trying to balance price stability and financial stability following the collapse of several banks. The 0.4% drop in retail sales was driven largely by auto, restaurant and gasoline purchases, the Census Bureau reported on Wednesday. But after stripping away those volatile components along with building materials, the control group—which feeds into the calculation of gross domestic product—rose by 0.5% in February. Markets had expected a decline of 0.3% for the control group. While the data was not adjusted for inflation, low inflation in goods, which make up most of total retail sales except for food services, should keep the change in sales volume of the control group in positive territory. The increase in sales of core categories, in addition to an upward revision from an increase of 1.7% to 2.3% for the prior month, should add more upside risks to our forecast of GDP in the first quarter, which had been 1.9% before Wednesday’s data came out. The monthly change in retail sales in the first couple months of the year should be taken with more than a grain of salt because of the volatility in seasonal factors. At the same time, it does not reflect what is happening inside the services sector, where most of the spending takes place. Barring what might spill over from the current instability in the banking sector, the data is consistent with our forecast of a slowdown in economic activities in the first half of the year before the economy tips into a recession in the second half.

Producer inflation

In a separate report from the Bureau of Labor Statistics on Wednesday, producer inflation eased for the second time in three months, dropping by 0.1% in February. January’s number was also revised downwardly, from 0.7% to 0.3%. Core producer prices that exclude food and energy were unchanged on the month, while the trade component, which is a proxy for retail and wholesalers’ profit margins, continued to plunge, down by 0.8% after a 1.1% decline in January. As demand continues to slow and supply chains improve, firms are facing thinner profit margins, which becomes even more problematic if sticky inflation is taken into account.

The takeaway

Wednesday’s data was a welcome sign as far as inflation was concerned. But it is not enough to change our forecast of another 25 basis-point increase by the Fed next week, despite the recent turmoil in the banking system. If the emergency measures to stabilize the banking sector work, the Fed should be able to walk and chew gum at the same time because it has been clear that inflation is its top priority.