Retail Sales Are Now Well Above Pre-Pandemic Levels

This recovery has been about goods consumption versus service consumption. Five months into the recovery, spending on goods is now well above the pre-pandemic February level. However, spending in the larger service sector remains below pre-pandemic levels, as people-facing sectors continue to face varied degrees of capacity restrictions and consumer fear.

The strong rebound in demand for goods was punctuated by today's retail sales report. Retail sales (price unadjusted) were up well above our expectation in September with a 1.9% month-over-month increase (now 5.4% year-over-year). Excluding autos, sales were up 1.5% on the month. The steep climb from the deep cycle-low in April has retained its momentum, with a string of new all-time highs since July that are beating the prior peak in January 2020. Sales are now back to pre-pandemic trend, with total sales for July 2020 through September 2020 up 3.6% from the same period a year ago. Adjusted for consumer price inflation, retail sales were up 2.3% over the same period.

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Sales Have Improved Broadly Across The Primary Categories

The price-related 1.5% month-over-month rise in gasoline station sales contributed to the rise in headline retail sales, as did the 3.6% increase in auto sales. The latter was broadly in line with the previously reported light vehicle sales from the manufacturers' books (16.3 million annualized in September, up from 15.2 million in August). Building material sales rose by 0.6% in September after upward revisions to previous months, further reconciling the undershoot versus other robust housing data. A strong demand in housing activity continued to show up in the National Association of Home Builders' confidence index (HMI), which hit a record high of 83 in September.

The big surprise was the strength of underlying control group sales (excludes gasoline stations, building materials, and auto sales), which gets directly factored into GDP accounting. Sales in the control group increased 1.4% month-over-month, the fastest pace since June, when parts of the country were still emerging from lockdown. Increases were broadly across 12 out of 13 major categories. As of September, sales at eight retail categories had already exceeded February's level. Nonstore (includes online) retailers outperformed all other retailers over this period (21.6% above February's level), and restaurants and bars were the worst performer (14.9% below).

The further increase in sales above pre-pandemic levels suggests that as the pandemic drags on, consumers are substituting additional goods purchases to make up for the ongoing shortfall in non-retail services spending. Because overall consumer spending (goods and services) consists mostly of services that have been disproportionately affected by COVID-19, the rebound in overall consumption has been slower than that of retail sales. As of August, it was still 3.4% below the pre-pandemic level.

Low Inventory Levels Point To A Boost In Manufacturing And Imports

Inventory levels are low after having gone through a sizeable liquidation. A modest rise in inventories relative to sales pushed the business inventories-to-sales ratio down to 1.32 in August (a six-year low), well below its recent historical peak of 1.67 in April and lower than the 1.39 in August 2019. Given the higher-than-expected sales through September, inventory-to-sales ratios are near historical lows. Retailers will look to rebuild inventories, especially as the holiday shopping season approaches. This should lead to increases in manufacturing production (a positive for GDP growth) and imports of consumer goods (a negative).

One would think that the need to rebuild inventories at the retail level would have led manufacturers to continue boosting production in September as well, but that wasn't the case. In September, industrial production surprised us by falling 0.6%, its first decline after four consecutive months of gains. Manufacturing output decreased 0.3% in September (driven mostly by the drop in the vehicle assembly rate) and was 6.4% below February's level. The output of utilities dropped 5.6%, as demand for air conditioning fell by more than usual in September. Mining production increased 1.7% in September, though it was still 14.8% below a year earlier, reflecting more generally low oil prices and--more recently--environmental factors. Mining activity rebounded from the downturn caused by Tropical Storm Marco and Hurricane Laura.

Nevertheless, the industrial output index increased at an annual rate of 39.8% for July-September. With the September pullback, industrial production has now recouped a little under three-fifths of the record drop in March and April combined. Capacity utilization fell to 71.5% from a upwardly revised 72.0% (was 71.4%) in September, which is 8.3 percentage points below the long-run (1972–2019) average.

Looking beyond the hiccup in September, manufacturers appear upbeat on their prospects for the near future. The latest example of upbeat sentiment in U.S. manufacturing is the early October survey from the Philadelphia and New York regions, both of which showed new orders and shipments resuming robust growth. The Philadelphia Fed's new orders (up 17.1 points to 42.6), shipments (up 9.9 points to 46.5), and average workweek (up 17.5 points to 25.3) sub-indexes all moved up to near record highs in October. The Empire State manufacturing survey's details on current activity and demand all improved, albeit not nearly as robustly as the Philly Fed's measures: shipments (up 3.7 points to 12.3), new orders (up 5.2 points to 17.8), and average workweek (up 9.4 points to 16.1).

Given the positive sentiments and support from the inventory cycle, machines are likely to add to growth, even as consumer spending will slow down in the next three months.

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What Does This Mean For Our Forecasts?

Data through September shows an upside risk to our third-quarter forecast numbers.

The solid goods consumption trajectory suggests upside risk for our GDP estimates of 29.5% in the third quarter, the advance estimate of which will be announced on Oct. 29, just before the election. The widely followed real time growth tracker from the Atlanta Fed is currently estimating a little over 35% annualized growth in the third quarter. If this were the actual case, the U.S. economy would be 3.1% below the fourth-quarter 2019 level (versus 4.3% in our forecast from September).

Consumer spending activity on goods was robust in the third quarter. Disposable income levels held up well despite a massive number of unemployed folks. That is because of the boost from government income transfers, forbearance on loan payments, and low interest rates. The more-than-usual income at one's disposal has helped building some precautionary savings as well, which should help somewhat offset the cut-off in the unemployment insurance amount in the fourth quarter.

However, momentum is likely to fade in the fourth quarter as growth in disposable income reverses back in line with the employment trend and unemployment benefits become more reflective of pre-pandemic levels. Still, short of major lockdowns across the nation from the new upsurge of COVID-19 cases, consumer spending and industrial output should remain in growth territory, albeit at a weaker pace.

For now, we are comfortable with our fourth-quarter annualized GDP growth forecast of 3.5%. There was a delay in Amazon Prime day from July to Oct. 13-14, and so there should be a respectable gain in next month's retail report (for October), even as the upsurge in the virus is likely to renew headwinds to growth in the coming several weeks. Positive manufacturing sentiments--combined with a supportive inventory cycle, rising home builder sentiments, and low interest rates--mean that the investment side of the growth picture should continue recovering in the fourth quarter.

Striking Data Of The Week

Core consumer price inflation (excluding energy and food) moderated in September to a 0.2% gain following 0.4% and 0.6% gains in previous months. On a year-over-year basis, the headline CPI and core CPI inflation now stand at 1.4% and 1.7%, respectively. Core goods prices have skyrocketed as supply struggled to meet demand, while core service prices have remained restrained. Shelter price inflation, which accounts for a sizable 33% of the CPI, decelerated to almost a nine-year low of 2% (year over year) and will likely continue to constrain headline inflation, even as nonpetroleum imports and domestic goods prices move up in the near term. Meanwhile, new vehicle prices rose 0.3% after a flat July figure and a 0.8% June gain. Demand of vehicles exceeds supply following factory shutdowns in the second quarter.

What caught our eyes was the prices of used cars and trucks. Used auto prices surged by 6.7% month-over-month in September, reflecting strong demand that is outpacing supply. Net purchases of used motor vehicles surged to an all-time high over the summer, as persons avoided mass transit and took advantage of historically low interest rates. On a year-over-year basis, used car prices are up 10.2%.

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Chart Of The Week

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Data Releases Of Past Two Weeks

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Calendar of Upcoming Economic Data Releases

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