Another Rate Hike? Seriously?
- The Retail Sales Control Group fell 0.1% vs. last month.
- Retail Sales were worse than expectations and caused even further cuts to GDP estimates.
- The underlying data in retail sales is actually even worse than the headline number with nearly every category showing deceleration.
- Inflation continues to decelerate and came if weaker than market expectations.
- The last two times the data was at this level, the Fed was gearing up to do QE. Now they are raising rates? Seriously?
Retail sales for the June reporting period were very weak and caused even the most optimistic analysts to question the prospects for high economic growth. I have consistently been on the opposite side of this, forecasting growth would continue to come in below estimates and that so far is what has been happening.
The retail sales control group, the number that feeds into GDP, declined to 2.48% year over year growth from 3.71% last month and down from 5.43% in January of this year.
Inflation decelerated to 1.65% this month; down from 2.54% in January of this year.
The Atlanta Fed continues to revise their estimate for Q2 GDP and now is forecasting growth of 2.4%. This is very far from 4.3%, where they started just a few weeks ago.
My estimate for Q2 GDP for the past several weeks has been 1.9%-2.4% and it is looking more likely that it will end up being in the lower end of that range by quarter end.
How can the Federal Reserve justify another rate hike with the recent data that was reported? They can't.
Below I will break down the recent data that was reported for retail sales and inflation and explain why the notion that the Fed will raise rates again is hypocritical to say the least.
Retail Sales Breakdown:
Source: (Census Bureau)
Retail sales is decelerating sharply and is now at levels of growth that were seen at the start of the last two recessions.
Retail sales is reported in nominal dollars (not adjusted for inflation) so to get real retail sales, a number more applicable to real GDP, you must make the adjustments on your own.
Below is a smoothed chart of real retail sales and the picture is even more troubling for the Fed if they truly do plan to raise interest rates.
Source: (Census Bureau)
As mentioned, you need to adjust retail sales for CPI or inflation to see the growth in retail sales in real terms. Instead of subtracting each month's inflation growth from retail sales, I instead subtract a 12 month average of inflation to smooth the volatility. Inflation can be volatile month to month which is why a smoothed measure of inflation provides a cleaner picture.
Real retail sales is falling precipitously and approaching a dangerous level near the zero bound in growth. The last two times that this measure crossed into negative territory, a recession occurred. Based on the current data and the trending direction, it is very likely that retail sales will cross into negative territory over the next few months. This of course does not guarantee a recession but it clearly illustrates a very weak and worsening picture of the consumer and the economy.
The question of whether a recession is near is not that relevant for this discussion. The takeaway should be that the last two times that real retail sales were at this level, a the Fed was cutting interest rates and providing accommodative policy tools.
How can the Fed now be talking about reducing the balance sheet and raising interest rates when growth in real retail sales is almost negative year over year? It is simply crazy.
Looking under the hood at the sub components of retail sales shows pervasive weakness throughout all the categories.
Source: (Teddy Vallee)
The above 12 panel breakdown shows the categories of retail sales in terms of year over year growth.
Every category except for one decelerated from a month ago, and most are down significantly from 6 months ago, making the overall trending direction of retail sales very clear.
What should be a cause for concern is that 'Non-store' or online sales growth is falling as well.
Online retail sales has been very strong over the past few years and it is the category that has been dragging up the overall rate of retail sales. With online sales decelerating, this should be a cause for concern.
Real retail sales are likely to hit negative rates of year over year growth in the next few months.
I wish the Fed luck on justifying the next rate increase with negative consumption.
The above charts on retail sales look anything but 'transitory'.
Source: (Census Bureau)
The past month's inflation report that was released this past week showed more deceleration in both headline and core inflation.
Core inflation has been plummeting over the past few weeks as seen in the chart above. The rapid drop in inflation is not 'transitory' despite what the Federal Reserve likes to say in order to make them feel better about missing their targets on growth and inflation for the past 9 years.
What is very puzzling and why I am so blown away by the Federal Reserve's recent mission to raise rates is that the core inflation is at the same level that it was the past two times they started a new quantitative easing program.
How is it that inflation can be at 1.7% now, and they are raising rates, and when it was 1.7% in the past, they started QE?
Not only that, growth in retail sales was higher than it is now.
To put it all into context, inflation was higher and growth was higher the last time they did QE, but now, with worse growth and inflation metrics, they are taking the opposite policy approach and raising rates.
This basically solidifies the belief of many that the Federal Reserve is not data dependent and conducts monetary policy on something other than growth and inflation data.
Source: (Atlanta Fed)
Several weeks ago, I posted an article in which I stated that the Atlanta Fed GDP forecast of 4.3% GDP was beyond ridiculous and that my estimate for Q2 GDP was 1.9% - 2.4%. That article can be read here: Did You Catch That?
Now, the current forecast for Q2 GDP by the Atlanta Fed is 2.4%, right at the top end of my estimated range.
My current belief is that GDP will continue to come down and end up at the bottom of that range by the end of the quarter, making the case for another rate hike even more hypocritical than it already is.
There is no data that can justify another rate increase based on what the Fed has said and what they have laid out as there targets for tightening monetary policy. They claim to target 2% inflation, but inflation is lower than 2% and moving in the wrong direction.
They also want to see a rebound in growth but as retail sales show, growth is not only weak but getting worse.
How can they raise rates and justify that they are data dependent? They cannot.
Another rate hike may happen but it would be unjustified and likely cause financial distress as they tighten into weakness.
I think the Fed is starting the process of backing off their tough talk as Janet Yellen and other Fed board members have been talking dovish in the past few weeks at various press conferences and interviews.
It is my opinion that they will not raise rates again and there will be no balance sheet reduction at all.
Growth will continue to slow, inflation will remain sub 2% and interest rates will stay lower for longer.
This is a tailwind for both bonds and stocks.
I would be allocated to both bonds and stocks based on the easier monetary policy to come. The fear in bonds is unjustified as they will not raise rates and reduced the balance sheet. They way I express this exposure in my Macro Allocation model is through TLT, iShares 20+ Year Treasury Bond ETF, and SPY, SPDR S&P 500 Trust ETF.
I would continue to add to both of these asset classes with the preference being bonds.
Raise rates? Reduce the balance sheet? Seriously?
This article was written by
Eric Basmajian is an economic cycle analyst and the Founder of EPB Macro Research, an economics-based research firm focusing on inflection points in economic growth and the impact on asset prices.
Prior to EPB Macro Research, Eric worked on the buy-side of the financial sector as an analyst at Panorama Partners, a quantitative hedge fund specializing in equity derivatives.
Eric holds a Bachelor’s degree in economics from New York University.
EPB Macro Research offers premium economic cycle research on Seeking Alpha.
Analyst’s Disclosure: I am/we are long TLT, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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