Retail Sales Boom Is Alive, But Maybe Not So Well

Summary

• May retail sales surprised with a drop of 0.3% as consumers cut back on big ticket furniture and auto purchases.
• But retail sales remain 17% above the pre-Covid trend, showing people are still spending vigorously.
• Covid apparently sparked a love affair with food. Grocery spend is still 14% above the pre-Covid trend, even as restaurant patronage is 10% above trend. It is little wonder many people report gaining weight.
• Retail sales are helping keep the economy going. But it could be too much of a good thing.

Market Implications

• Should a recession come, there could be a catastrophic collapse in retail sales. That would deepen an economic downturn.
• Alternatively, if consumers are forced to slow spending, that could tip the economy into recession.

Introduction

Retail sales surprised on the downside – total sales were down -0.3% versus +0.1% consensus forecast. Ex autos, sales were up 0.5% versus 0.7% forecast. That is hardly surprising given rampant inflation and shrinking real incomes.

Yet retail sales continue to be extraordinarily strong.

Covid Spending Habits Are Firmly Ingrained

Retail sales have grown predictably and monotonically over the past 30 years due to ongoing population growth and (until very recently) a mild updraft of inflation.

Come the Covid pandemic, retail sales soared far above the long-term trend as people suddenly had to buy a lot of stuff to augment their new homebody and work-from-home lifestyle.

You might have thought this spending would have run its course by now. But the surprising thing is that retail sales remain 17% above trend (Chart 1). To put it another way, May retail sales totaled $672.9bn; had they returned to trend, they would have been $115bn lower.

Looking at spending by category, the biggest gainer by far was gasoline sales, up 4% from April and 6.9% over two months (Table 1). Restaurant and grocery sales were also strong, rising 1.2% and 0.7% respectively – inflation certainly helped there. Meanwhile, big ticket items like furniture and autos were weak. People are not cutting back on driving or eating, but they seem to be watching some of their pennies.

Covid Sparked a Love Affair With Food

It is worth unpacking the food related spending further.

We all know Covid changed our lives in many and profound ways. One surprising (and little noticed) change is a love affair with food. When the pandemic lockdowns hit, people started spending far more on groceries instead of going to restaurants (which mostly had to close). That is no surprise (Chart 2).

And as the economy reopened over the past year, people have not been able to get enough of eating out. Restaurant patronage is 10% above the long-term, pre-Covid trend. You might think people would be spending less on groceries. But remarkably, grocery spending remains some 14% above trend and shows little sign of slowing. Various anecdotal sources suggest some 60% of people gained weight during the pandemic. If retail sales data is any indication, many people are still gaining weight.

Retail Spending Is a Risk Factor

We have expected retail sales to slow for months now as consumers switch back to services. But it is becoming apparent that Covid caused more lasting shifts in spending and eating habits. Retail sales are helping to keep the economy going. Yet it could be too much of a good thing.

That could change. As Chart 1 shows, retail sales collapsed during the financial crisis recession and took 2.5 years to recover. At the time, retail sales were about 8% above the long-term trend. Given how much further above trend retail sales are now, a recession (if it comes) could be exacerbated by a collapse in retail spending.

Alternatively, if inflation and falling real incomes force people to cut back on spending, that could be the straw that breaks the proverbial camel’s back and tips the economy into recession.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.