Market Insider

January spending weakness is temporary because consumers are about to get a big boost

Key Points
  • January's surprising drop in retail sales makes it appear there's a weakening of the consumer, the engine for about two-thirds of the economy.
  • But economists say the report, and the negative revision to December sales, is likely only temporary.
  • The consumer should get a boost from the impact of tax cuts, which should start to show up in paychecks this month.
Customers shop at a Target store in Chicago, Illinois.
Getty Images

January's shocking drop in retail sales looks like there was a body blow to the consumer, but economists say it is likely a temporary hit and the positive impact of the tax bill should more than make up for it.

Retail sales, a measure of consumer spending, fell 0.3 percent, compared with an expected gain of 0.2 percent, and December's report was also revised lower. It was the worst decline since February 2017.

Economists say even with the December revisions, it's unlikely the report is signaling a longer-term weakness in the consumer, the engine for about two-thirds of the U.S. economy.

"The underlying fundamentals for the consumer are still pretty good. The unemployment rate is still moving lower, job growth is strong and consumer confidence remains elevated. It doesn't look like the consumer's going to go into any sort of pullback here," said Kevin Cummins, senior U.S. economist at Natwest Markets.

The retail sales number was released just as the consumer price index showed the biggest pickup in inflation in the past year. CPI rose 0.5 percent, or 2.1 percent year over year, a much sharper jump in prices than the 0.3 percent expected. Economists also expect inflation to rise more slowly, and Cummins said inflation has a pattern of running higher in January than other months.

The consumer also has seen wages rising, but could get another bump in pay.

"I think there's a lot of things related to that tax package we haven't really seen before," said Drew Matus, chief market strategist at MetLife. "There are almost 8 million workers that work at firms that announced some kind of improved benefits, or bonuses or wages, and I have to assume that has to do something for consumer confidence."

Most taxpayers should see a benefit from the tax plan, and that should begin to show up in paychecks this month.

Even the Fed should not be concerned much about the soft spot in spending and is expected to continue on its course to raise interest rates. "The way they'll interpret this is they'll look at the outlook and say, hey, we have tax reform coming. People should have more after-tax income beginning in February. That should create more aggregate demand going forward," said Joseph Song, Bank of America Merrill Lynch U.S. economist.

Cummins said spending should also pick up as consumers get their tax refund checks.

January's weakness could be blamed on the weather, Matus said. He said the drop-off in some spending, such as vehicles, could be directly tied to cold weather. But he said apparel sales rose and prices increased as well, suggesting the bitter cold of January resulted in more winter clothing purchases.

"When something happens that's going to be weak in the first quarter, we're going to blame it on the weather. We're blaming it on the weather," he said.