Retail: April's Sales a Blow to Those Expecting Quick Snap Back

The 0.4% drop in retail sales in April is a blow to those expecting a quick snap back in economic output in the near term. Consumer demand accounts for 70% of output in the U.S. and stabilization in consumption is a necessary condition for recovery.

Soft numbers for April retail sales are in contrast to anecdotal evidence from retailers that sales picked up last month. The rise in January sales were buoyed by one time gains in social security benefits and reduced withholding taxes. A recent mortgage refinancing boom is expected to boost incomes and extend the recovery in spending, but that thesis is not being corroborated by the data.

The rate of contraction in the U.S. economy has slowed but the date of recovery remains a point of great debate. I have argued that household savings will continue to rise over the next few months forestalling a near term recovery.

Those in the optimists’ camp are expecting a big snap back in production in the coming months. They argues that production has fallen too hard—even farther than demand warrants--judging by the fact that destocking accounted for roughly half the fall in GDP in the first quarter of 2009.

Clearly, this trend will not continue indefinitely and production will need to rise to meet even weak demand. However, the chance of a major rebound in production is diminished by the continued weakness in consumer demand. A milder increase in production is the more likely scenario meaning that when the recovery arrives it will be weak.

A slower recovery will translate to near term weakness for the stock market and commodity prices and raises the prospects for a near term rally in government bonds. This is not necessarily a bad thing because the snap back scenario for growth would increase the probability of a double-dip in output. A slow and steady rebuilding of stock would be better. The substantial rise in commodity prices in recent weeks is at risk to correction because it is discounting a significant recovery in global demand that is yet to arrive.