Is the Economy Too Strong?

Major stock indexes are down so far this month, taking a break following a rather impressive 9-month rally. Economic data continue to beat expectations and fear of imminent recession has faded. Bond prices are also falling back, allowing yields to float higher. Investors are wondering whether an unexpectedly strong economy might cause the Federal Reserve to keep interest rates high for the foreseeable future.

China reported retail sales and industrial production growth below expectations in July. Growth simply hasn’t reaccelerated after the country’s dictatorship ended Covid Zero policy restrictions. In the past, authorities were quick to boost government spending and enact other stimulus measures to counteract weakness in the economy. But recently the regime has been hesitant to follow the same rubric because it seems to have caused a property bubble. Several high profile property development companies recently defaulted on debt payments and Bloomberg News says “fallout from a deepening property slump [is] spread[ing] to the financial sector.” China’s central bank just lowered interest rates to encourage growth. That may help, but there’s no easy solution. Investors are calling for a much bigger policy response.

Meanwhile, US retail sales jumped .7% in July from the prior month (and 3.2% from a year ago). June sales were revised higher as well. Strength was partly driven by Amazon’s Prime Day, which was obviously a one-time benefit. Even so, consumer spending is clearly resilient because jobs are still plentiful and at last wages are growing faster than inflation. But are the numbers too good? Bloomberg News says, “Too much strength…could force the Federal Reserve to pursue more aggressive policy should inflationary pressures prove sticky.”

This retail sales report (from the US Census Bureau) mostly covers purchases of goods rather than services. Data suggest that even while goods prices are decelerating, the dollar value of purchases is growing. The one service category it includes—restaurants & bars—posted a rather large monthly gain of 1.4%. This data feeds into the government’s “gross domestic product,” or GDP formula, which measures overall growth in the economy. You might guess that growth is tracking far higher than anticipated at the beginning of the year. In fact, the Atlanta Federal Reserve now estimates third quarter GDP growth at a rather ridiculous 5.7%. Here again, if the Federal Reserve judges that the economy is at risk of overheating, they have every incentive to keep interest rates at elevated levels.

Target (TGT) reported disappointing second quarter results. Same-store sales fell 5.4% from the year-ago quarter, far below analysts’ forecast of -3.7%. Food, beverage and heath merchandise fared well, but discretionary categories were again weak. The CEO called out “macro pressure,” which I take to mean lingering inflation. Also, the company’s bizarre experiment with “pride” apparel led to what he called “negative reaction” from customers. Using another odd euphemism, he mentioned “adjusting mid-quarter to address safety concerns.” I’m not sure whether this refers to the pride apparel or the fact that since 2019 shoplifting losses have doubled and the company is increasingly concerned about the safety of its employees. Anyway, there was some good news: inventory fell 17% during the quarter and less discounting resulted in better profit margins. Also, after the pride apparel was removed or hidden in back of the stores, business recovered somewhat in July. Target stock has been under pressure, falling about 50% over the last couple of years. So as weird and uninspiring as this report was, it actually boosted the stock by 3%.