How Strong are Retail Sales

Retail sales data were released today. At first glance, the number seemed disappointing -- retail sales fell by 0.4% (read article). There is, however, a quirk you need to know about when analyzing this number: it is a nominal value. Why is that a problem? Gasoline prices fell dramatically in September, giving the impression of retail weakness, when in reality that was not the case. To see this, recall that:

nominal retail sales = price x quantity

When a critical price falls dramatically, as that of gasoline did, we have a large drop in the price term, which tends to make the growth rate in retail sales low or negative, as was the case this month. Similarly, in months where gasoline prices rise, this will tend to push up the value of nominal retail sales.

So, at the present time, or any time when gasoline prices change substantially, gauge retail sales strength by focusing on retail sales excluding gasoline (and retail sales at service stations). For September, retail sales excluding sales at service stations rose by a respectable 0.6%. What a different perspective this gives!!

An important part of macroeconomics is knowing how to "read the tea leaves." The Carnes and Slifer book is very good for this (you should read the material dealing with retail sales). This is one more example of why it is important not to examine only overall indicator values without delving into greater detail.

Now, as the more meaningful real trend of retail sales indicates economic strength, the bond market sold off again today, pushing the 10-year bond rate all the way up to 4.8%. Read this story to see the details. It's safe to say that the bond market has dramatically changed its perspective from just one week ago. The likelihood of a Fed rate cut early in 2007 is somewhere between slim and none. Don't forget that the Fed Chair and several members also need to establish their "cred." Erring on the side of ease would be a major error they would suffer from for years to come. So, for them, it is preferable to err on the side of causing weakness than to risk higher inflation.