Retail Sales Comes in Significantly Lower Than Expected

May retail sales significantly underperformed expectations, printing at -0.9% versus the -0.6% consensus, driven by declines in auto parts and building materials; import and export prices also weakened, with export prices falling -0.9%, the worst in two years. Despite the weaker data, the market expects the Fed to hold steady on interest rates at its meeting concluding Wednesday, attributing the retail sales weakness to tariff-related distortions rather than a fundamental economic slowdown, with rate cut expectations diminishing for 2024 and beyond.

Analysis

May's economic data presents a mixed, predominantly weaker picture, significantly influenced by trade policy uncertainties. Headline Retail Sales for May unexpectedly fell -0.9%, markedly below the -0.6% consensus and the lowest since January, with a prior month revision downwards from +0.1% to -0.1%. This weakness was broad, evidenced by Auto Parts declining -3.5% and Building Materials by -2.7%, although Sporting Goods (+1.3%) and Furniture (+1.2%) showed growth. Excluding auto sales, the figure was -0.3% against an expected +0.1%, and ex-autos & gas, it registered -0.1%, a substantial miss from the anticipated +0.3%. A singular positive was the Control group number, a key input for PCE inflation metrics, which rose +0.4% after a downwardly revised -0.1% in April. The report suggests these figures reflect tariff realities and a "pull-forward" effect, referencing a prior +1.7% month-over-month retail sales surge in anticipation of such complications. Trade data further underscores this narrative: May Import Prices were flat at 0.0%, below the prior +0.1% but better than the -0.1% expectation, while ex-fuel import costs rose +0.2%. More strikingly, Export Prices plummeted -0.9%, the sharpest drop in over two years, with year-over-year U.S. exports at +1.7%, the weakest this year and 80 basis points below the +2.5% forecast. This emerging global trade dynamic is negatively impacting export pricing. Despite these weaker indicators and a strongly negative market sentiment (-0.7), the Federal Open Market Committee, commencing its meeting, is not expected to alter interest rates. The prevailing view is that these economic aberrations are largely tariff-related, and the Fed awaits clarity on global trade before adjusting rates to manage inflation and foster employment, with odds for a rate cut before September below 50% and some analysts now forecasting no cuts in 2025. Pre-market futures reflect this caution, with the Dow down 180 points, S&P 500 down 20, and Nasdaq down 90, while bond yields are reported as slightly lower, with the 10-year at 4.41%, the 2-year at 3.94%, and the 30-year at 4.92%.

Key Decisions for Investors

• Investors should note the significant underperformance in May's retail sales and export prices, which, while attributed to tariff distortions, still signal potential headwinds for consumer spending and international trade-exposed sectors.
• Given the Federal Reserve's anticipated hold on interest rates pending clarity on trade impacts, and diminishing expectations for rate cuts in 2024 or even 2025, positions sensitive to prolonged higher rates warrant careful review.
• Monitor upcoming PCE inflation data, for which the retail sales Control group provided a positive input, and subsequent retail and trade figures to discern underlying economic trends from tariff-induced volatility before making significant portfolio adjustments.
• The current strongly negative market sentiment and negative sentiment for major indices (DIA, SPY, QQQ) suggest a cautious short-term outlook, advising vigilance and possibly a defensive posture until greater economic clarity emerges.