Introduction

Weakening growth rates in Europe and China have been grabbing the economic headlines so far this year. And though the news coming out of the U.S. has been headlined by unusual strength in the labor market, this week's set of data may be more in line with the global downshift. Retail sales in December proved one of the most unexpectedly weak reports in memory, in what was bad news for both the nation's retailers not to mention fourth-quarter GDP estimates.

The economy

GDP forecasts got a major haircut after an unexpectedly weak verdict for December holiday sales. Retail sales fell 1.2 percent for the sharpest monthly decline of the expansion, since September 2009 and the last recession. The twist in the data is that vehicle sales, not really part of the holiday season, contributed strongly to December's results and excluding which sales fell an even more severe 1.8 percent. Aside from autos, the only other major component that was not in the minus column was building materials, up 0.3 percent for a group that is also not part of the holiday season. A major 3.9 percent drop for nonstore retailers jumps out of the details and points to a disappointing holiday for e-commerce. Sales at apparel stores fell 0.7 percent in December with department stores down 3.3 percent. Restaurant sales lost 0.7 percent for a second month in a row. Adding even more to December's downside was a 5.1 percent drop in gasoline sales that reflected lower price effects.

The year-on-year rate for total sales also tells the story, falling nearly 2 percentage points to 2.3 percent for its lowest reading since late 2016. This is a third of the growth rate back at mid-year when consumer spending was the driving force behind the 3.4 and 4.2 percent annualized growth rates of second and third quarter GDP. Yet retail spending makes up only 1/3 of total consumer spending in which services are the biggest category. And though spending on services may very well hold stable, the big drop for retail betrays an edginess among consumers, perhaps the results of what was a pending government shutdown back in December that nevertheless contrasts very starkly with the enormous strength of the labor market. Still the upshot is clear: consumer spending has moved to new lows.

Increasing the sense of shock from the December retail sales report was that it was delayed for a month because of the government shutdown. The shutdown, however, didn't affect the quality of December's data which the Census Department strongly attests to. A report that is truly mysterious, or at least a bit mysterious, is unit vehicle sales as they include both consumer purchases and businesses with neither stripped out. This uncertainty aside, January's edition, in the wake of December's retail crash, is uncomfortably ominous for the consumer. Unit sales fell very steeply in the month, to a 16.6 million annualized rate from 17.5 million in December. The month-to-month drop points to a similar decline for dollar sales of vehicles in the coming retail sales report for January. Vehicles were actually a plus for December though you would never know it looking at the 1.2 percent headline drop. And with unit sales falling sharply, January's retail sales report looks like it will be an uphill battle. And for February retail sales? Well there may not be much improvement here either based on the Redbook's same-store index for the February 9 week which slowed abruptly to its lowest rate since September.

The main reason that the drop in retail sales took everyone by surprise is that the jobs market is so strong. In fact, the job market is arguably too strong — that jobs are being created much faster than people can fill them. Job openings continue to accelerate much faster than hiring, up 3.1 percent in December's JOLTS report to a 7.335 million level that easily exceeded Econoday's consensus range. And the gap between openings and the 6.294 million who were actively looking for work in December came to 1.041 million which is next only in the record book to November's 1.098 million.

Like job openings, hiring is also on a sharp climb but is lagging, up 1.6 percent in December to 5.907 million. The gap between openings and hires is now 1.428 million, a new record and up from 1.304 million in November. Year-on-year comparisons further underscore the dislocation with openings up 29.4 percent vs only a 7.1 percent gain for hires. Given how difficult it is for employees to fill openings, it's no surprise that the number of layoffs & discharges fell 3.2 percent in the month to 1.697 million. In contrast, the number of employees who quit rose 1.0 percent to 3.482 million in what hints at worker mobility and the pull from higher paying rivals. But year-on-year the rise in quits is still moderate at 4.3 percent with layoffs & discharges subdued at 2.5 percent. There are already lots of red signals in this report and perhaps the most important one for the Federal Reserve and its vigilance against unwanted inflation will be if and when the quits totals start gaining more significant traction.

The lack of inflation coming out of the labor market has without a doubt been this cycle's biggest anomaly and may very well be the central reason why inflation has been as subdued as it is. Actually, the consumer price report has been very easy for forecasters to predict: flat again and again and again. Overall prices, for a third straight month, were unchanged in January with the core rate up 0.2 percent for a fifth straight month. The graph tracks these monthly readings out to two decimal places which, given its importance, is common when evaluating consumer prices and which in any case gives the graph a little variation. But still not that much variation.

Turning to the year-on-year comparison, the headline rate, reflecting energy effects, is moving lower, down 4 tenths in January to 1.6 percent though the core rate, which excludes energy as well as food, held roughly steady at 2.2 percent. The move lower for the overall rate may open some eyes among the doves at the Fed, but the core rate is just about where the Federal Reserve wants it be, straddling the 2 percent target. If lack of wage pressure is a constant negative for inflation then energy is probably a temporary one. Energy prices extended their steep decline to three months in a row, down a month-to-month 3.1 percent with gasoline down 5.5 percent. Year-on-year energy is down 4.8 percent with gas down 10.1 percent. Though November's collapse in oil from $70 to $50 has been pulling inflation down ever since, the effects are likely to wear off soon which should begin to help the year-on-year reading at least hold steady.

Consumer prices may be described as flat but this would not be a fair description for import and export prices which are clearly going down. Import prices for January fell 0.5 percent in a third decline in a row that was not skewed by petroleum which edged 0.1 percent lower. Excluding petroleum, import prices dropped 0.7 percent. Year-on-year, import prices were 1.7 percent lower in January for the weakest showing in 2-1/2 years. Export prices fell 0.6 percent which is also a third straight drop. Agricultural prices fell 2.1 percent but follow strong gains in the prior two months. Year-on-year, export prices were down 0.2 percent in January with agricultural prices up slightly but very slightly, at 0.2 percent. Finished goods continue to show very little life though prices for capital goods exports did rise 0.4 percent in the month to lift their annual gain to 1.4 percent. This is moderate but compares well against the 1.7 percent decline for total import prices. This gain, however, is isolated as export prices for consumer goods fell a monthly 0.4 percent while import prices for consumer goods fell 0.3 percent and import prices for vehicles fell 0.2 percent.

The final nails in the coffin for the week's inflation news proved to be the inflation expectations measures from the University of Michigan and the Atlanta Fed. Inflation expectations at the consumer level fell a sharp 2 tenths to 2.5 percent while expectations at the business level fell 1 tenth to 1.9 percent. Both are the weakest showings in more than a year when reflating the economy was a common concern. Maybe the need for reflation will pop back up especially given how closely the Fed watches inflation expectations as a general indication for future inflation. Much like January's vehicle sales extended the weakness of December's retail sales,  inflation expectations are extending what may be inflation's less-than-favorable outlook.

A reversal from an oversized December gain pulled down industrial production volumes by a sharp 0.6 percent in January in yet another of the week's reports that isn't pointing to accelerating strength. Manufacturing production, as tracked in the graph, fell 0.9 percent after rising 0.8 percent in December. Vehicle production has been behind much of manufacturing's two months of swings, falling 8.8 percent in January after rising 4.3 percent in December. But business equipment, falling 1.5 percent after December's 0.9 percent gain, has also contributed to the volatility. Utilities, up 0.4 percent, helped limit the weakness while mining was only marginally positive, at 0.1 percent. But mining is still the standout component as year-on-year volumes in the sector are up 15.3 percent. This dwarfs manufacturing's yearly rate of 2.9 percent which, because it excludes price effects, is deceptively low. When including inflation, manufacturing is running in the mid-single digits which is really just about perfect, that is solid and sustainable. This report isn't as bad as it looks and averaging December and January together points to modest but still positive activity for the industrial sector.

Markets: Dovish Fed doesn't dent dollar

The Fed's move to neutral late last month hasn't pulled down the dollar which instead has been getting a lift from global economic slowing and dovish headlines from other central banks including the Reserve Bank of Australia and especially the Bank of India which, in a surprise move, cut rates in the prior week. The dollar index rose 0.3 percent in the latest week and, at 96.90, is back near its high of last year. Currency effects on the economy have been limited over the past year but increasing dollar strength could pull imported inflation even lower and would also hold down the nation's exports, both unwanted outcomes. And Brexit right now may be a dangerous wild card for further strength in the dollar as a hard pullout from the European Union could very well make for sharp losses in both the pound and the euro.

For stocks the week was positive. Word that top negotiators were to meet late in the week built up optimism early in the week that the U.S. and China may very well reach a constructive agreement on trade. Reports late in the week that negotiators had agreed to broad outlines sent shares further higher on Friday. The only stumbling block on the week was Thursday's sharp drop in December retail sales that cut back fourth-quarter GDP estimates, roughly from above the 2 percent range to below the 2 percent range. On the week, the Dow gained 3.1 percent, the Nasdaq 2.4 percent, and the S&P 2.5 percent. This has been a very good so far for stocks with the Dow up a year-to-date 11.0 percent.

The bottom line

The nation's retailers not only find themselves in a sudden uphill battle, but first-quarter GDP also looks to be at risk whether from a slump in vehicle sales or a slump in manufacturing production. And though the jobs market remains very strong, the consumer has visibly lost steam. Against all this may be an eroding inflation picture which, in hindsight, could very well be pointing to accommodative pivot ahead for central policy.

Week of February 18 to February 22

It will be a light week bookended by Presidents Day on Monday and a data-free session on Friday. The recent run of weak consumer and manufacturing data have not included much news on a sector that was weak throughout last year, that's housing. Home builders will post their sentiment index on Tuesday and another month of slight improvement, following a late-year plunge, is the expectation. Manufacturing gets back in the news on Thursday with durable goods orders which are expected to show a solid headline gain but weakness underneath including for capital goods. Housing then comes back with existing home sales on Thursday where only a modest bounce from a 3-year low is the call.

Tuesday

Housing Market Index for February

Consensus Forecast: 59

Consensus Range: 54 to 60 

A second month of improvement is the expectation for February's housing market index where the call is 59 following what was a better-than-expected 2-point gain to 58 in January. The sudden plunge in this index began in November with an 8-point rout to 60.

Thursday

Durable Goods Orders for December

Consensus Forecast, Month-to-Month Change: 1.2%

Consensus Range: 0.0% to 3.5%

Durable Goods Orders, Ex-Transportation

Consensus Forecast: 0.3%

Consensus Range: -0.3% to 0.8%

Durable Goods Orders, Core Capital Goods (Nondefense Ex-Aircraft)

Consensus Forecast: 0.1%

Consensus Range: -0.2% to 0.5%

Extending strength is the expectation for December durable goods orders where the consensus is calling for a 1.2 percent gain vs November's increase of 0.8 percent. Ex-transportation orders, however, have been soft but are expected to improve to a 0.3 percent increase vs a 0.3 percent decline in November. Core capital goods orders have been mixed, falling sharply in November after rising strongly in October. Here the consensus is for only a 0.1 percent gain.

Initial Jobless Claims for February 16 week

Consensus Forecast: 225,000

Consensus Range: 220,000 to 225,000

Initial claims have moved higher in part due to the government shutdown during January, effects that appear to be easing. Econoday's consensus for the February 16 week is 225,000 vs 239,000 in the prior week.

Philadelphia Fed Manufacturing Index for February

Consensus Forecast: 14.0

Consensus Range: 12.0 to 15.2

Easing strength at a consensus 14.0 is the call for Philly Fed's manufacturing index for February which in January easily beat expectations at a very solid 17.0. A key highlight from the January report was a surge in new orders which points to general strength for February's activity.

PMI Composite for February Flash

Consensus Forecast: 54.1

Consensus Range: 53.0 to 54.4

PMI Manufacturing

Consensus Forecast: 54.2

Consensus Range: 53.0 to 54.6

PMI Services

Consensus Forecast: 53.9

Consensus Range: 53.0 to 54.2

Noticeable firming for manufacturing and steady strength for services made for no change in the composite PMI for January at 54.4 (January updated from a 54.5 flash). The consensus for February's flash PMI composite is for little change at healthy growth of 54.1 split between a services consensus at 53.9 and a manufacturing consensus at 54.2.

Existing Home Sales for January

Consensus Forecast, Annualized Rate: 5.050 million

Consensus Range: 4.900 to 5.100 million

Lower mortgage rates and an easy comparison against a very weak December point to monthly improvement for resales in January. Econoday's consensus for January existing home sales is a 5.050 million annualized rate vs a more than 3-year low in December of 4.990 million.

Index of Leading Economic Indicators for January

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.0% to 0.2%

The consensus for January's index of leading economic indicators is a rise of 0.2 percent vs a 0.1 percent decline in a December report that was pulled lower by the stock market and sharp slowing in ISM manufacturing orders.