Weak retail sales reports and a drop in the Empire State index confirm the credit market crisis has spread at home
If there were any doubts that a sizable credit market jolt is now rippling through the U.S. economy, reports on September U.S. retail sales and the October Empire State manufacturing index released Oct. 15 have eliminated them.
Consumer spending posted a significant "U-turn" right around the peak in commodity prices in mid-July, and it's likely that a combination of diminishing credit availability and soaring levels of fear are continuing to drive sales down, and the savings rate up, as we enter the fourth quarter. The weak Empire figures suggest that businesses are following suit, which bodes poorly for the final quarter of 2008. Meanwhile, figures on U.S. business inventories released Oct. 15 correspond with likely contractions in economic growth in both the third and fourth quarters.
Additionally, the September producer price index provided a reminder to the Federal Reserve that its problems go beyond providing assistance to a hobbled U.S. banking system, as the U.S. is facing a continued ugly inflation outlook even while the economy contracts and the financial sector implodes.
For the Fed, chaos in the financial markets will dominate the Oct. 28-29 policy meeting, though an accommodative policy will also be endorsed by likely downward forecast revisions for growth and inflation. Yet, the Fed is likely still uncomfortable with the unusually low 1.5% Fed funds rate target that has been deemed necessary for performing the lender-of-last-resort role, and the firm September "core" price data in the PPI report are a reminder of why many members will resist further rate reductions if possible. The obvious risk, however, is that the exceptional times will prompt capitulation from Fed inflation hawks, who may accept further Fed funds rate reductions.
Here's a look at the Oct. 15 reports:
The U.S. retail sales report revealed big September sales declines, with the headline figure plunging 1.2% (vs. economists' median forecast of -0.7%), while the ex-auto aggregate fell 0.6% (median -0.2%), that followed downward July and August revisions. Most of the components declined on the month, led by vehicles (-3.8%), furniture (-2.3%), and clothing (-2.3%).
The data mix in the September report solidifies the view that consumers retrenched powerfully starting around the mid-July peak in commodity prices. It still isn't clear to what degree the pullback was driven by credit restraint vs. fear, but it is perhaps likely to reflect some combination of both.
We now expect real (inflation-adjusted) consumption to post a 3.0% rate of decline in the third quarter, following the 1.2% rise in the second, while nominal consumption posts a 2.2% third-quarter growth rate following the 5.5% second-quarter clip. Our third-quarter gross domestic product forecast has been lowered to -0.5%, following 2.8% growth in the second quarter, while our September personal consumption expenditure (PCE) forecast now sits at -0.3%, with a flat chain price figure.
The U.S. business inventory report of an expected 0.3% overall August gain included a 0.6% drop in retail inventories with a 1.6% drop for the volatile vehicle inventory component. The retail figures accompanied the already-reported August inventory gains of 0.8% in the wholesale sector and 0.6% in the factory sector.
The August inventory figures are consistent with our assumed $36 billion inventory contribution to third-quarter GDP. The inventory-to-sales (I/S) ratio bounced in August to 1.27 from the remarkably low 1.23-1.24 readings over the prior three months. The bounce partly reflects "price effects," as the sales figures typically capture more of the price adjustments with big commodity market swings than the inventory figures.
If retail sales extend their substantial third-quarter weakness into the fourth quarter, as we indeed expect, the overall I/S ratio should rise to the 1.32 area. The rise will place downward pressure on production plans of inventory managers as we approach the new year and is bad news for the early-2009 outlook.
Producer Price Index
The U.S. PPI report, with its 0.4% September headline drop but surprisingly firm 0.4% core (excluding food and energy prices) increase, revealed a year-over-year headline gain at the expected 8.7% from 9.6%, while the core year-over-year rate popped to 4.0% from 3.6%. The headline year-over-year rate is still well above what was the 26-year high of 7.4% as recently as January, hence showing how far the commodity price reversal still needs to go to reverse the price surge of the past year.
We continue to expect the September CPI report to show a flat headline reading that leaves year-over-year growth moderating slightly to 5.0% from 5.4%, alongside a 0.2% core gain that leaves that year-over-year rate at the same 2.5%.
We expect the September PCE chain price figures to show the same monthly swings as with CPI, to leave year-over-year gains of 4.1% overall and 2.5% for the core.
Empire State Index
The U.S. Empire State index dropped to a -24.6 reading in October, following the September decline to -7.41. While the various components of the report were quite weak, one jumps out: The capital expenditure plans index moderated to 6.10 in October from 16.09, which unwinds the modest gains over the past two months and brings this measure to a new cycle-low. The drop raises the risk that businesses will indeed post the feared pullback in investment spending in the fourth quarter, following what appears to be a turn in the durable goods, factory goods, and nonresidential construction spending data starting in the middle of the third quarter.
We will now assume a decline in the October Philly Fed headline index to -8.0 from 3.8. For the remaining major sentiment indexes in October, we expect a drop in the Chicago PMI index to 51.0 from the surprisingly firm 56.7 September reading, alongside a 44.0 reading for the ISM manufacturing index, vs. 43.5 in September, and a 49.0 figure for the ISM services index, vs. 50.2 in September.