The Policy Conundrum: Still Solid Growth and Consumption with a Fed Desperate to Cut

This morning, retail sales were flat (0.0%) in June following an upwardly revised 0.3% increase the month prior. According to the median forecast, retail sales were expected to decline 0.3%. Year-over-year, retail sales rose 2.3% in June, the smallest annual gain in four months.

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Car sales fell 2.0% in June following a 1.0% gain the month prior, while gasoline stations sales dropped 3.0% in June, the second consecutive monthly decline. Excluding autos, retail sales rose 0.4% in June, the most in three months, and climbed 3.4% over the past 12 months. Excluding autos and gasoline, retail sales rose 0.8% and increased 3.8% year-over-year. Finally, excluding food, autos, building materials and gasoline station sales, control group sales rose 0.9% in June, the most in three months, and gained 4.1% over the past 12 months, the largest annual increase in three months.

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In the details of the report, non-store retailer sales increased 1.9%, building materials sales rose 1.4%, and health and personal care sales gained 0.9% in June. Also, clothing sales increased 0.6%, and furniture sales also rose 0.6% in June. Additionally, electronics sales rose 0.4%, as did general merchandise sales with a similar gain in department store sales, miscellaneous sales increased 0.3%, eating and drinking sales gained 0.3%, and food and beverage sales rose 0.1% in June following a 0.2% decrease the month prior.

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On the other hand, sporting goods sales fell 0.1% at the end of the second quarter following a 1.7% gain in May.

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Also this morning, import prices were unchanged in June, despite expectations of a 0.2% decline, and export prices fell 0.5% at the end of the second quarter, more than the 0.1% decline expected. Over the past 12 months, import prices rose 1.6% and export prices gained 0.7%, both marking the largest annual increases since January 2023.

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Bottom Line: This morning’s retail sales report paints a significantly stronger picture of spending digging beyond the headline number. With core sales (ex. autos and gas) rising 0.8% coupled with upward revisions to the prior months, it’s clear the U.S. consumer remains solid. Such resilience will prove a?welcome support to growth in Q2 and beyond, but poses a challenge for the Federal Reserve desperate to provide relief from a 23-year high in rates.?

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Policy makers – and investors – were buoyed by a cooler-than-expected CPI report, suggesting a September rate cut is not only on the table but increasingly likely. However, with a hotter-than-expected read on the PPI and import prices suggesting still elevated price pressures, conditions clearly fall short of the Committee’s threshold of “many” good months of data needed to instill confidence in a sustained disinflationary trend. Furthermore layering on continued strength in spending, a near-term rate reduction may not only be unjustified, at least in the next 63 days, but potentially counterproductive in the longer-run quest for price stability given the current level of rates is clearly not yet having the desirable?and more substantive retarding impact on spending.?

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Of course, that’s not to say the Fed can’t or won’t raise rates nor should they wait to reach 2% before taking action. After all, Federal Reserve Chairman Jerome Powell himself appears increasingly focused on the ground already covered rather than the remaining pathway back to 2% or full employment. Noting again the substantial improvement in inflation coupled with a further cooling in the labor market, Powell said the Committee is going to be looking at both mandates. Speaking yesterday at the Economic Club of Washington D.C., Powell added, “They're in much better balance.”

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But optimism – or desperation – aside, the current stance of economic conditions do not yet indicate a reason, let alone a need, to reduce policy firming. Thus, even if the Fed did opt to open the door to rate cuts as early as Q3, the Fed will likely be limited in action, disappointing investors’ hopes of returning to neutral or below sometime soon. Meaning, perhaps the Fed is able to eke out one or two rate reductions in the near term followed by a second-round extended pause.? ?

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Yesterday on the economic calendar, the Empire Manufacturing Index fell from 6.0 to -6.6 in July, the lowest reading since May and marking the eighth consecutive month of decline. According to the median forecast, the index was expected to decline to a reading of -7.6. In the details of the report, prices paid climbed two points to 26.5, the number of employees increased from -8.7 to -7.9, averaging a reading of -5.9 over the past six months, and new orders rose from -1.0 reading of -0.6. On the other hand, prices received dropped one point to 6.1, inventories fell from +1.0 to -6.1, a four-month low, and the six-month general business conditions index declined from 30.1 to 25.8 in July, a two-month low.

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Also this morning, business inventories rose 0.5% in May, as expected an following a 0.3% increase the month prior.

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Finally this morning, the NAHB Housing Market Index unexpectedly fell one point to a reading of 42 in July, a seven-month low.

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Tomorrow, another key report of the week will be released – June housing starts and permits.

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Last month, starts unexpectedly fell 5.6% in May and dropped 19.3% year-over-year, the largest annual decline since April 2023. Building permits, meanwhile, fell nearly 4% in May, and decreased 9.5% on an annual basis, the fourth consecutive month of decline. This month, starts are expected to rise 1.8% in June, and potentially drop 8.1% on an annual basis, following a 19.3% drop in May, while permits are expected to decline 0.1% in June, and fall 7.2% over the past 12 months, potentially marking the fifth consecutive month of decline.

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Later in the week, on Wednesday, the Fed will release the latest version of the Beige Book likely underscoring that economic activity continued to “expand,” but that “conditions varied across industries and Districts.”

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On Thursday, weekly jobless claims, the July Philly Fed Business Outlook Index, and the June Leading Indicators Index will be released.

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On the Fed-speak front, later today at 2:45 p.m. ET, Fed Governor Adriana Kugler will speak at a NABE conference in Washington.

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-Lindsey Piegza, Ph.D., Chief Economist