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Will 50 Basis Points Circumvent a Recession?

Last week, the Commerce Department reported that Retail sales increased 0.3%. The primary growth driver came from autos. Excluding auto sales, sales fell 0.4%. On a year-over-year basis, sales increased 4.2% and 4.5% excluding autos. This was much stronger than the growth during June and July. As we have discussed, some of the strength is from the shift in the school year in a couple of key states. Several retail sectors experienced acceleration in sales growth. Clothing stores (+7.1%), general merchandise (+7.1%), sporting and book (+8.3%) all had year-over-year growth rates two percentage points higher than last month.

Best Buy reported second quarter results that exceeded analysts' estimates, but results were not as spectacular as the headlines read. Most of the strength came from its international operations. International same store sales jumped 16.3% compared to domestic comps of 1.7%. Consumer electronics same store sales actually declined 1.6%. Notebook and gaming sales offset flat TV sales. Flat panel TV sales remained strong. Appliances had a -7.1% comp as the weakness in the housing market continued to pressure results. Gross margins continued to drop, but the 60 basis points drop was much less than the 150 basis point compression experienced during the first quarter.

Housing starts dropped 36,000 units to 1.331 million annualize rate. This was lower than economists expected. Permits also dropped lower than expected, to 1.307 million. These are both the lowest levels since 1995. The National Association of Home Builders reported that builder optimism fell two points to 20. This was the seventh consecutive drop and tied the lowest level recorded since the survey started in 1985. Only the component tracking buyers traffic fell, traffic was flat. Credit Suisse held a homebuilder conference this week where Robert Toll, CEO of Toll Brothers said, "Trends are weak right now based on activity since early August. Our experience is that it's worse than '80-'82 or '87-'91. Not quite as big as '74, but '74 was short lived."

Consumer prices dropped 0.1% in August, which was the first monthly decline in ten months. The year-over-year increase in the Consumer Price Index slowed to 2.0%, which was the smallest increase since November 2006. Lower energy prices the key contributing factor. Energy prices dropped 3.2% during August and off 2.5% from last August. This trend will likely reverse as crude oil reversed in mid-August and is currently trading in all-time record territory.

While the government is able to report that inflation is muted, companies have continued to raise prices. Procter & Gamble accounted a 9% increase on fabric softener. Sara Lee increased bread prices 5%. During its conference call this week, General Mills said it plans more price increases to offset rising costs. It is planning for another 5% increase in costs for 2008.

The Fed made its first unexpected move in years this week as it lowered the target rate 50 basis points to 4.75. Most pundits expected a 25 basis point cut. The larger than expected cut, caused some to worry that the economy is weaker than the recent data suggest. We discussed last week how we felt once lenders curtailed consumer lending, there would be a sharp declaration in consumer spending. It appears the Fed shares this concern and has opted to aggressively try and circumvent a consumer led recession. We also mentioned that there was a lack of consensus on where the Fed would navigate interest rates by the end of the year. Tuesday's larger than expected 50 basis point reduction of the Fed funds target rate heightened the uncertainty. The most likely path is no change through the end of the year, but this is only about one-third probability. Last week, the probability that the target rate ended the year at 4.75% was 53%.

 

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