Retail pains could help control inflation
U.S. consumers are shifting their dollars from merchandise to services like travel, a worrying trend for retailers that benefited from the pandemic spending binge but a promising sign for snarled supply chains and inflation.
For months, economists have been expecting demand for merchandise to wane as COVID-19 fears subside and Americans spend on experiences such as vacations and entertainment. The expectation was that a decline in spending on goods would ameliorate supply-chain pressures and help to tamp down decades-high inflation.
That dynamic is finally starting to happen. And it's having a dramatic effect on a stock market that's gotten used to rock-solid earnings and margins from consumer stalwarts. The S&P 500 plunged more than 4% Wednesday, with a basket of consumer discretionary stocks headed for its lowest close in almost two years.
Earnings reports this week from retail giants
Walmart and Target showed a slowdown in spending on general merchandise items that had buoyed profits the last two years. Target Chief Executive Officer Brian Cornell went so far as to say shoppers were stepping back from big-ticket items such as televisions to buy restaurant gift cards or luggage as the pandemic abates. The company's stock fell 25% on Wednesday.
Meanwhile, airlines including United Airlines Holdings and Southwest Airlines expect strong sales in the coming months amid pent-up demand for summer travel.
From the perspective of federal policymakers, any slowdown in merchandise inflation is positive, since that's the component that's led to the fastest year-overyear inflation since the 1980s. Inflation for services, while rising more recently, has largely maintained its pace from previous years. Lower demand for goods would also alleviate pressure in the shipping and labor markets.
Walmart's earnings report was “another example of goods deflation and consumers shifting preferences at the margin,” Dennis DeBusschere, founder of 22V Research LLC, said in a note Tuesday. “That's good for inflation, but the question remains the same: Is disinflation going to happen fast enough for the Fed?”
Dimmer retail outlook
A shift in spending away from higher-margin general merchandise items is crimping earnings just as retailers struggle with big cost increases that have prompted Walmart and Target to trim their profit outlooks. Investors have been unforgiving, with Walmart falling the most since 1987 on Tuesday and Target on track for a similar decline Wednesday.
It's still unclear how quickly — or whether — the shift in consumer spending away from goods will cool price pressures. But any signs of a slowdown in inflation is a good sign for the Federal Reserve, which has become increasingly concerned about rising prices. Fed Chair Jerome Powell said Tuesday that the central bank will keep raising interest rates until there is “clear and convincing” evidence that inflation is in retreat.
Inflation-adjusted spending on goods fell 0.5% in March from the prior month, while services rose 0.6%, matching the biggest gain since July. Not adjusted for inflation, the gain in services spending was broad-based and led by components including international travel, restaurants and hotels, according to the Commerce Department.
Target's Cornell said the company was surprised by the speed of the change, which is weighing on profit expectations.
The retailer saw a “rapid slowdown” in apparel, home goods and hardlines, a category that includes sporting equipment and electronics, he said. Food and beverage sales were strong, but those goods tend to have lower profit margins.
Target said it would continue offering discounts this quarter to pare inventories, which could give the Fed an assist in its battle against inflation. Walmart has said it wants to keep its inventory at a healthy level to ensure its shelves remain stocked, but the recent increase in merchandise is too high.