RBC Economics Report

No time to do a post today so here is a RBC Economics Report that outlines some of the reasons for today's market action. These bad numbers were in addition to the massive asset writedowns at Citigroup and CIBC. Interesting times indeed.

U.S. retail sales growth dropped 0.4% in December
Rishi Sondhi, Economist

U.S. retail sales growth dropped 0.4% in December, a much weaker result than the market’s expectation of flat sales. However, the sales decline was following a very robust, although downwardly revised, 1% gain in November. Ex-autos, sales were down 0.4%, again weaker than expectations.

The drop in retail sales in December was, in part, attributable to nominal sales at gasoline service stations dropping 1.7%. However, this partly reflected a decline in gasoline prices. Excluding this component along with the volatile motor vehicle and building material components, sales were actually up 0.2%, building on November’s downwardly revised 0.8% gain (previously reported at 1.3%).

The portion of retail sales that feeds into quarterly spending — retail sales ex autos, building materials and garden equipment, and supply stores — fell a slight 0.1% after surging 1.6% in November. During the November-December holiday period, sales were up 0.3% on average, compared to 0.7% in 2006 and 0.4% in 2005.

The U.S. retail sales figures are consistent with a drop in real spending in December, which we currently estimate to be -0.1%. Despite the likely decline, November’s real spending surge makes it highly likely that spending will come in above 2.5% in the fourth quarter. Slower spending in December does suggest somewhat softer spending momentum heading into the first quarter of 2008. We expect consumer spending growth to weaken to a 1.5% annualized pace during the first three months of the year.

The softer first-quarter 2008 momentum implied by the weaker-than-expected retail sales data will likely keep the Fed aggressive with their policy actions in order to mitigate the downside risks to growth. We are expecting that the Fed will opt for 50 basis points of cuts at their January 29-30 policy meeting.

Modest decline in U.S. producer prices; core prices rise
Paul Ferley, Assistant Chief Economist

The December producer price index fell 0.1%, a substantial slowing from the 3.2% monthly increase in November. The earlier strong increases are keeping the year-over-year rate high at 6.3%, although this is down from the 7.2% recorded in the previous month. On a core, or ex food and energy, basis, December prices were up 0.2% and 2.0% during the past year. The monthly increase was down from 0.4% in November, although the year-over-year rate was unchanged from the previous month.

The moderation in the overall monthly increase was largely a reflection of the 1.9% fall in energy prices in December after surging 14.1% in November. The moderation was tempered by a 1.3% rise in food prices after recording no change in the previous month. Upward pressure was evident in a number of food components, including fresh vegetables, beef and veal, and processed fruit and vegetables.

The moderation in core prices largely reflected a 0.9% drop in passenger cars after a 0.6% jump in November. Car companies are likely cutting prices to help move out the remnants of the old car lines as the 2008 models are rolled into the showrooms.

Today’s report indicates that earlier energy price increases are keeping the annual increase in producer prices high at 6.3%. The year-over-year increase in core prices is rising a much more moderate 2%, although this is likely at the upper end of what is deemed as acceptable by the Fed. As well, Fed Chairman Bernanke has gone to great lengths to emphasize that the Fed had not taken its eye off the risk of higher energy prices putting even greater upward pressure on the core measure. However, despite these risks, the near-term focus of the central bank is to ensure that the economic expansion continues in the face of the ongoing financial market volatility and attendant credit tightening. Thus, today’s report does not alter our view that Fed funds will be lowered a further 100 basis points during the first half of this year, with the first installment, a 50-basis point cut, coming at the conclusion of the next FOMC meeting in January 29-30.