Retail sales topped expectations in July

Retail sales rose by a sizable 0.7% in July, nearly doubling up the consensus forecast for a more sedate 0.4% increase. Moreover, the gain can’t be attributed to some of the usual suspects; it wasn’t a function of a spike in gas prices or a surge in car sales. Take both of those off the table and the increase was an even more pronounced 1.0%.

It looks like it can be chalked up to robust, widespread, organic spending growth, with one hitch: consumers pared spending on higher-ticket items. Auto, furniture, and electronics retailers saw declines for the month; the latter two have contracted meaningfully over the past year on the heels of the initial “stay-at-home” buying binge in the early stages of the expansion. Higher interest rates have undoubtedly played a role as well, given the greater probability and need for consumers to borrow for those purchases.

Beyond those sectors, gains were both solid and widespread.

What does it mean? First, it’s critical to acknowledge that one month doesn’t make a trend, so any enthusiasm should be tempered by that reality. Still, the strength of the increase suggests that perhaps the proverbial “death” of the consumer spending is still premature. Perhaps consumers are catching their second wind as inflation recedes and healthy labor market conditions continue.

At the same time, the near-term outlook for consumers isn’t without challenges. The economy will still have to slog through the ongoing effects of waning fiscal stimulus, reduced liquidity, and higher interest rates in the coming months. Cracks are still emerging in credit markets, but there’s ample evidence that the flow of credit has eased — not a surprise given the significant, rapid tightening by the Fed and anticipation of a slowdown.

The big question remains: can the Fed engineer a soft landing for the economy, or is the so-called “most widely anticipated recession ever” still on the horizon? Recent data on inflation, the labor market, and consumer strength have provided encouragement for those in the soft-landing camp. Still, a range of leading indicators remain soft.

Ironically, any signs of a resurgence in demand or persistent strength in labor conditions could lead the Fed to further stiffen their resolve and tighten further or, at a minimum, delay a potential easing.

That risk has been borne out in the continued rise in long-term yields, as illustrated by the uptick in the 10-year Treasury yield on the heels of this morning’s retail sales report. That yield now hovers near 4.25%, having risen sharply from about 3.7% less than two months ago.

The bottom line? Consumers spent with vigor in July, perhaps with a sense of relief that inflation is fading even in the absence of recession or extensive job losses. Is a soft landing still on the table? It’s certainly possible, but it seems a stretch to conclude that it’s probable. For now, it appears that the more likely scenario is that the outlook is for a recession that has been deferred but not dodged. How long can consumers continue to spend? The answer will be critical to the question of how long this expansion can persist, and how much more the Fed may feel compelled to do to ensure that inflation will return to a more palatable level.

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