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Inflation is making consumers miserable. To judge from retail sales, that might not matter—for now. But lofty inflation expectations are a warning worth heeding, potentially signaling slower economic growth ahead.
When the Commerce Department reported October sales across retail and food-services stores, the results far exceeded expectations, with total sales rising at the fastest pace since March. On the heels of a surprisingly sluggish third-quarter gross-domestic-product report that showed the slowest pace of growth since the recovery began, solid retail sales reminded investors that U.S. consumers are flush, shopping, and still powering economic activity.
You wouldn’t know it, though, to look at confidence surveys. Take the latest report from the University of Michigan. Consumer sentiment fell in early November to its lowest level in a decade, says Richard Curtin, the survey’s director.
The details are even drearier: A quarter of U.S. households expect their financial situation to deteriorate, the biggest share since 2008; half of respondents say the national economy has recently weakened and will continue to do so in the year ahead; and nearly six in 10 consumers think bad times financially will persist in the next five years. Economists at Goldman Sachs say the recent declines in the Michigan gauge would imply a 0.4% drag on fourth-quarter annualized consumption growth, which accounts for about two-thirds of GDP.
What consumers say and what they do don’t always jibe. Some economists shun sentiment surveys, viewing them as useless when spending data are readily available each month. After all, the golden rule of behavioral economics is to observe what people pay, not what they say, economist Dan Geller notes.
But it isn’t that simple. Since retail sales are reported in nominal terms, meaning the data aren’t inflation-adjusted, it is worth considering the corresponding increase in the consumer price index. That’s a back-of-the-envelope way to inflation-adjust the sales figure, says Citi economist Veronica Clark. Applying the CPI roughly suggests that higher prices represented about half of the October increase in sales, with actual sales volume representing the balance.
Higher prices aren’t altogether bad. Companies are successfully passing on climbing wages, rising material prices, and surging shipping costs, protecting profit margins and then padding them some more. Anxious about supply-chain challenges, retailers began pushing out a wave of holiday deals in October, a report from software company
shows. But those deals have been skimpy. Prices rose in 12 of 18 categories last month; they almost always fell, on average, during the same period from 2015 to 2019.
Expectations for record-high corporate profit margins of 13.1% this year, 13.2% next year, and 13.8% in 2023 are proof that cost pressures aren’t squeezing margins, says Ed Yardeni, president of Yardeni Research. Retailers’ stocks are benefiting. The
SPDR S&P Retail
exchange-traded fund (ticker: XRT) is up 10% this month and 61% this year, far outpacing respective gains of 2% and 25% in the S&P 500 index. Consumers might not be happy about it, but they are paying up.
At least for now. “I wouldn’t look at it and say, ‘All our concerns are gone,’ ” notes Citi’s Clark of the upside retail sales report. “Part of it is that prices are pulling forward holiday shopping,” she adds.
While solid October sales augur well for fourth-quarter GDP, Clark cautions of possible payback in November and December, with sales in those months potentially lower because consumers shopped earlier.
Therein lies one reason not to discard survey data that are so glaringly conflicting with reality, or at least the reality before it is adjusted for inflation. Curtin at the University of Michigan attributes falling confidence almost entirely to rising prices. While respondents widely reported nominal income gains, half of all families foresee reduced real incomes next year, and a quarter say they already feel inflation is reducing their standard of living, he says.
Consumers speeding up purchases in anticipation of higher prices is the very dynamic central bankers fear. If real-world prices shape inflation expectations that wind up determining actual inflation, perception becomes reality. In fact, the report’s measure of inflation expectations over the next year edged up to 4.9%, the highest since 2008, with 71% of all consumers surveyed predicting higher prices in the year ahead.
It’s important to note that long-term inflation expectations within the latest Michigan survey held at 2.9%—elevated, but not alarmingly so. One reading: Consumers buy the narrative that inflation is mostly transitory, believing that rates of prices increase will slow after next year. But not everyone is sold.
Tom Porcelli, chief U.S. economist at RBC Capital Markets, notes that the share of people expecting inflation to be around the Federal Reserve’s 2% target over the next year has fallen sharply, and is near the lowest level observed over the past few decades. The number of people predicting inflation of 3% or higher has shot up dramatically, driven by the share of people anticipating inflation of 15% or more.
Few things are seeing prices rise at that pace. “But the simple fact that people perceive it that way should be enough to scare the Fed,” Porcelli says, adding that inflation fear is widespread, with the entire income distribution on the same page.
The question isn’t whether consumers feel inflation and expect it to run higher over the next year. It’s whether consumers are spending now because of those rising inflation expectations at the expense of future spending—or in spite of them.
Write to Lisa Beilfuss at [email protected]