This morning’s data deluge provided a perfect snapshot of the U.S. economy at the current time. A robust consumer, driven by strong real compensation in the first quarter of the year, continued to prop up the American economy, even as the domestic manufacturing sector contracted by 0.5% on a year-ago basis.
The major aftermath of today’s data deluge? Current risk-averse sentiment among investors is likely to continue favoring fixed income over stocks.
For those not keeping score at home, fixed-income investors continue to focus on the risks associated with the trade war and financial conflict. That conflict has kicked out the chair underneath global and domestic manufacturing, leaving in its wake narrower margins and volatility in the stock market, despite robust retail sales data implying there is not an imminent risk of a U.S. recession in the current quarter. The major aftermath of today’s data deluge? Current risk-averse sentiment among investors is likely to continue favoring fixed income over stocks. In our estimation, the deterioration in domestic manufacturing and volatility across financial markets should push the Federal Reserve to cut interest rates by an additional 50 basis points at its September meeting, in line with our call for an additional 50 basis points in cuts through the end of 2019.
Retail sales
A surge in compensation to U.S. consumers supported a robust 0.7% increase in monthly retail sales, fueled by a 2.8% increase in non-store retail activity—the proxy for e-commerce driven by Amazon Prime Day launched July 15. On a year-ago basis, retail sales are up 19.3% on a non-seasonally adjusted basis. Non-store retail sales now account for roughly 23% of the all-important control group subset. The control group, which feeds into the calculation of GDP, jumped 1%, which will put a floor under overall economic growth during the current quarter. On a three-month average annualized pace, retail sales soared 7.5% and those in the control group jumped 9.7%.
Due to the month-to-month noise, we do not focus on any one month and prefer to measure the condition of the consumer by way of retail sales on a three-month average annualized basis. While the July data was clearly strong, we would suggest that the current pace of spending likely peaked in May, and will come back down to earth in coming months.
It’s important to note that 40% of consumers—representing the two upper income quintiles—accounts for 60% of household spending. Given the volatility in equity markets and flat to falling house prices at the upper end of the housing spectrum, it would not be surprising to observe an easing in the pace of overall spending not too dissimilar to what was observed during the first three months of 2019.
In addition, for those following their first business cycle, here is an important reality check: U.S. household consumption increased 3.9% in December 2006. Six months later the U.S. economy had entered recession, despite a sustained expansion in consumer spending that lasted until the first quarter of 2008.
Industrial production
Just as one got that warm fuzzy feeling from retail sales, the July U.S. industrial production report provided the cold splash of coffee. Industrial production declined 0.2% in July and manufacturing fell -0.4%. On a year-ago basis, the manufacturing sector contracted at a 0.5% basis, while overall industrial production advanced 0.5%. This bearish data was supported by a 3.1% increase in demand for utilities, driven by hot summer season. In our estimation, the manufacturing sector is either in or soon will be entering a recession.
Productivity
While most of the attention, and deservedly so, will be put on the retail sales and industrial production data, the general improvement in the productivity data is somewhat encouraging. While the 2.3% increase in the top line reflects general deceleration in the economy, beneath the headline one notices a large upward revision in Q1 2019 unit labor costs, from an initial 2% to 7.2%. Moreover, compensation per hour increased at a 9.2% pace; when adjusted for inflation it climbed 8.3% in the first quarter of the year. In the second quarter, compensation increased 4.8%, and when adjusted for inflation, was 1.8% higher. That jump in compensation is one of the major reasons why the U.S. consumer was able to prop up the American economy during the second quarter of the year, and is largely responsible for the robust run of monthly retail sales reports that continued through July.
If the upset in financial markets continues, the Fed should strongly consider cutting the policy rate by 50 basis points at its September meeting.
Hours worked were flat during the first six months of the year, which will result in a likely slowdown in productivity going forward, and makes sense given the decline in fixed investment by businesses noted in the second-quarter GDP report. A quick look at the data implies productivity should slow to 1%, which will impact long-term potential growth and the real equilibrium interest rate. In our estimation, this, too, supports our call that the Federal Open Market Committee will cut rates by another 50 basis points later year. If the upset in financial markets continues, the Fed should strongly consider cutting the policy rate by 50 basis points at its September meeting.
Initial jobless claims
First-time jobless claims for the week ending August 10 increased to 220,000, slightly above our preferred metric of the 13-week-moving average, which arrived at 216,000. We are not concerned about initial jobless claims in this cycle until they climb above 250,000 which is one of the primary reasons why we do not think that there is a recession risk in the current quarter.
