Retail Sales Point To Consumer Downshift

The strong headline gain of May retail sales disguises the underlying pullback, which is the real signal. Retail sales rose 0.6% after a 0.1% rise in April. The consensus was for a 0.4% increase.

The weakness is evident though on an underlying trend basis. The three-month annualized pace for the headline, ex-auto measure and the core measure used for GDP calculations (excludes auto, gasoline and building materials) are lower than the 6- and 12-month pace.

Core Sales
Specifically, the three-month annualized pace of core sales stands at 2.7% in May, down from 3.4% in Q1 and 4.4% in Q4 '12. Retail sales accounts for roughly 40% of personal consumption expenditures.

Auto sales rose 1.8% in May, according to the retail sales report. This is the strongest of the year. We note that auto incentives jumped to 8% of market value in May, according to Edmunds, which is tantamount to about $2500 a vehicle, the most in about two years. Auto companies are sacrificing margins for sales volume. It appears to have taken these incentives to keep the auto sales at the pace seen in recent months. During the worst of the economic crisis, the incentives were worth about 10% of the vehicle's price.

Autos
Japan's Nissan has cut the prices of some of its models, but this seems more about the industry than claims Japan is exporting deflation. Volkswagen reportedly has introduced a new lease program that does not require any up front cash.

GM, Ford and Chrysler have also offered even greater incentives. Chrysler's incentives are worth about 10.3% of the vehicle's price. GM's incentive rate is estimated near 10%, which includes the $500-$750 cash offer on Chevrolet during the late-May holiday sales period. Ford has been offering incentives worth about 9% of the vehicle's value. Some industry analysts expect even greater sales incentives over the summer, especially for trucks, to prepare for the new 2014 models in September.

Imports Tumble
Separately, the US reported import prices tumbled 0.6% in May.
The consensus expected a flat report after a revised 0.7% decline in April (initially was -0.5%). This warns of downside risks to tomorrow's PPI report. The consensus expects a small uptick after a 0.7% decline in April.

It is here we can see better the impact from Japan. Import prices from Japan fell 0.4% on the month and are off 1.4% year-over-year. The yen declined 21.5% in the 12-months through the end of May. Japan account for 6% of US imports. Consider US imports from Latam. They account for almost 20% of US imports. Prices fell 0.3% on the month and 3.5% on a year-over-year basis. As a simple exercise, this illustrates that the supposed deflation headwinds from Japan are quite minor thus far. Overall, import prices have fallen for three consecutive months. Excluding food and fuel, import prices are about 1.2% lower than a year ago. Consumer goods prices are flat, while imported industrial goods prices are 4.6% lower than a year ago.

Exports
Separately, and less significant for our purposes here, export prices fell 0.5% on the month and are off 0.9% year-over-year. This is about half the pace at which import prices are falling and suggests a positive terms of trade impact.

The bottom line is that the conundrum of falling easing measured inflation despite the continued expansion of the Fed's balance sheet will continue to bedevil economic orthodoxy. Today's reports show the consumption moderating and price pressures easing. This is not the kind of economic data that will give Fed officials who want to taper much ground to stand on. Clearly, after the price action of the last couple weeks, arguments that the QE is creating bubbles have been, well, deflated.

Today's data, however, should help the capital markets stabilize, though the yen and Japanese assets, more than dollar and US asset markets, are the wild cards.