Stocks declined on Wednesday as investors adjusted expectations for potential Federal Reserve interest rate cuts following stronger-than-expected retail sales data. The latest economic reports have cooled optimism that the central bank will embark on a cycle of rapid easing to combat slowing growth and elevated inflation.
Retail Sales Jump in December
The Commerce Department reported that retail sales rose 3.0% in December, significantly outpacing economists’ forecasts for a modest 0.1% increase.^^[1] The robust gain indicates resilient consumer spending even in the face of stubbornly high inflation and rising interest rates.
Category|December Sales|Forecast|November Sales
—|—|—
Overall Retail Sales|3.0%|0.1%|-0.6%
Motor Vehicles & Parts|-1.1%|-0.9%|-1.3%
Furniture|1.3%|0.1%|-0.6%
Electronics|2.7%|0.2%|-4.2%
The broad-based strength across retail segments suggests the consumer economy retains momentum heading into 2023 despite macroeconomic headwinds. The report led traders to scale back expectations that the Fed will rush to slash rates by 50 basis points at upcoming policy meetings.^^[2]
“It throws cold water on the ‘recession is just around the corner’ thesis,” said Anu Gaggar, senior global investment analyst for Commonwealth Financial Network.
Stocks Pull Back from Recent Gains
Major stock indexes declined in morning trading after posting strong gains to start 2023. The S&P 500 fell 1.6%, and the tech-heavy Nasdaq Composite shed 2.1%.^^[3]
The indexes had rallied more than 6% since the start of January amid growing conviction that slowing growth would spur Fed policymakers to quickly reverse course on interest rates. However, analysts say markets “got a bit ahead of themselves,” pricing in rate cuts as soon as this summer despite resilient economic activity.^^[4]
“Equities are repricing expectations of Fed cuts,” said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management.
Treasury Yields Climb on Economic Strength
Strong retail sales numbers drove benchmark 10-year Treasury yields up 7 basis points to 3.54%, retracing part of January’s decline.^^[5] Rising yields reflect lowered expectations for aggressive Fed rate cuts that could soften the central bank’s inflation fight.
“The economy is clearly not falling off a cliff which is what the equity market has been telling us,” said Dec Mullarkey, managing director of investment strategy at SLC Management.
Shorter-dated yields sensitive to rate cut views also rose. The 2-year Treasury yield climbed 5 basis points to 4.11% after hitting a three-month low of 3.88% last week.
Oil Prices Edge Up Amid Demand Hopes
Oil prices ticked higher as the retail sales figures eased some fears that a potential recession will sap fuel demand. Brent crude rose 0.9% to $86.29 a barrel, adding to this week’s gains.^^[6]
Meanwhile, Energy Information Administration data showed a larger-than-expected drop in U.S. crude and gasoline inventories last week.
Still, analysts cautioned that lingering concerns about a global economic slowdown could continue weighing on the oil market outlook.
“Much needed demand from China is missing currently while developed economies may be headed for a slowdown or even recession,” said Tamas Varga of oil broker PVM.
FedSpeak in Focus
Markets await public appearances from several Fed officials, including Vice Chair Lael Brainard, for further clues about the policy path.
Comments suggesting resilience in consumer demand and stickiness in underlying inflation despite easing price pressures could pour cold water on hopes for rapid rate cuts. Such a messaging could spur another leg higher in Treasury yields and downward pressure on stocks.^^[7]
“The market believes the Fed is done in February,” said Commonwealth’s Gaggar. “If Fed speakers push back on that narrative, it won’t be received well.”
Overall, analysts say solid retail spending demonstrates underlying economic momentum despite tightening financial conditions. While markets may see near-term volatility, the strength points to a potential “soft landing” scenario where the Fed manages to cool demand without triggering a severe downturn.^^[8]
Outlook Hinges on Inflation Trajectory
The debate around peak inflation and Fed policy is likely to dominate markets in coming months. Most analysts expect pricing pressures to continue moderating, allowing the central bank to halt and eventually reverse rate hikes to support growth.
“Inflation is still the biggest question,” said SLC’s Mullarkey. “We expect it will settle around 3%, allowing the Fed more flexibility.”
However, a re-acceleration in inflation absent clear signs of demand weakening may force central bankers to stick to an aggressive tightening campaign despite market turmoil.
“The Fed has been clear: they need actual progress in bringing down services inflation, wages and inflation expectations before declaring victory,” noted analysts at BlackRock in a research note.^^[9] “Risks remain tilted toward higher rates.”
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