Dollar Strengthens after Retail Sales Disappointment and Revisions Mask Pickup in Spending

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-USD rises even after August retail sales surprise on the downside.

-Revisions wreak havoc on data, recent growth faster than forecast.

-Fresh "trade war" detente and US politics convolute USD outlook.

The Dollar strengthened Friday after U.S. retail sales surprised on the downside for August, in what first appeared to be a classic sign of risk-aversion, as revisions to prior numbers showed recent sales growth was faster than previously thought.

Retail sales rose by just 0.1% during August which, down from an upwardly-revised 0.7% in July, was far below the consensus for growth of 0.4%.

Core sales, which exclude large-ticket items like cars from the data because of their distortive impact on underlying trends, rose just 0.3% after posting an upwardly-revised increase of 0.9% in July.

The core number was below the consensus for an increase of 0.5% but given that July's growth rate was previously reported at just 0.6%, the more-important core retail sales have still grown faster in the last two months than markets had previously thought they would. This, rather than risk-aversion, could explain the positive reaction from the Dollar Friday.

"Gains in US retail sales ran out of steam somewhat in August, although upward revisions to the prior month made up for the disappointment," says Andrew Grantham, an economist at CIBC Capital Markets. "As such, today's data shouldn't change our forecast for real consumer spending and GDP printing around 3% in Q3, and market reaction should also be limited."

Markets care about the retail data because it is a leading indicator of economic growth and because of the influence that rising or falling consumption can have on inflation. It is inflation that central banks are attempting to contain when they raise interest rates, and rates themselves are the raison d'être for most moves in currency exchange rates.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"The net revision to prior data was +0.2% for the headline and a hefty 0.4% for non-auto sales, so the new level of the latter is a bit higher than implied by the consensus, though we expect markets to focus more on the soft-looking August numbers. A 0.8% drop in auto sales hit the headline August print," says Ian Shepherdson, chief US economist at Pantheon Macroeconomics.

The US Dollar index was quoted 0.11% higher at 94.64 following the release after extending an earlier 0.02% gain, while the Pound-to-Dollar rate was 0.11% lower at 1.3095 and the EUR/USD rate was down 0.11% at 1.1678. Both latter rates have deepened losses since the data were released.

"As for the outlook, we have to be cognisant of the near-term risks to retail sales from weather disruption, including Hurricane Florence. This has the potential to lead to some big swings in the data over the next few months, just as we saw last year with hurricanes Harvey and Irma," warns James Knightley, chief international economist at ING Group. 

Knightley highlights that U.S. households have a tendency to stockpile goods ahead or hurricanes, as well as pick up their spending in subsequent months as they repair damaged homes and property. But he warns this kind of "splurge" will only last for so long and that after it tapers off, retail sales growth will fall. 

This phenomenon can be problematic for investors and markets that are attempting to gauge the true underlying strength of the U.S. economy. It could also lead to volatility in U.S. Dollar exchange rates.

"Although retail sales were weaker than we had been expecting in August specifically, upward revisions to sales in the previous months mean that real consumption growth still appears to have remained quite strong in the third quarter," says Andrew Hunter, an economist at Capital Economics.

Friday's data follows inflation numbers for August, which showed US consumer price pressures moderating during the recent month, with both headline and core numbers declining further than markets had anticipated.

"If core inflation doesn't pick up more meaningfully next year, that would result in an even more gradual pace of rate hikes. As such today's figures may be slightly negative for the US$ and see long-term yields fall a little," says CIBC's Grantham, in a note Thursday.

Weaker inflation appeared initially as if it would undermine the consensus that price pressures are rising and cast doubt over expectations for interest rates next year. But not all see Thursday's report as a game changer.

"Treasury yields edged down on Thursday following the softer-than-expected 0.1% m/m gain in core consumer prices in August, with the annual core CPI inflation rate dropping back to 2.2% from 2.4%. Nonetheless, wider evidence suggests that there is still upward pressure on prices, which should ensure that the Fed continues hiking interest rates once a quarter," says Capital Economics' Hunter.

The Federal Reserve (Fed) has raised interest rates seven times since the end of 2015, taking the Federal Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so that the top end of that range hits 3.25% around the end of 2019.

"The US CPI does not derail the Fed but it adds to a slow drip-feed of marginal negative news flow for the USD. It does, however, shine a spotlight on the high-frequency growth data, which are steadily turning less USD supportive," says Mark McCormick, North American head of FX strategy at TD Securities. 

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Trade War Detente Played Down

August's data comes after the Wall Street Journal reported Wednesday that U.S. officials have sought fresh talks with Chinese counterparts over the tariff fight between the world's two largest economies.

This led to a moderation of unease about the so-called "trade war" and sent the safe-haven Dollar lower during that session. Thursday's inflation data and continued optimism that a US-China deal can be reached have kept the Dollar on its back foot ever since. But some analysts are warning that this could be folly. 

"Another meeting alone does not signal a break through or change in position by either the US or China. Without immediate trade progress, there is still a high risk that President Trump will follow through on plans to impose tariffs on a further USD200 billion of imports from China. For high beta commodity related and emerging market currencies to stage a more sustainable rally, it will require more concrete evidence that trade tensions between the US and China are de-escalating," cautions Lee Hardman, a currency analyst at MUFG.

President Donald Trump has announced the intention to impose tariffs on Chinese exports worth a total of $250 bn, although the levies on $200 bn of this number are yet to actually be introduced. Trump said at the weekend he is ready to move forward with those tariffs but that whether he does or not will depend on actions from the Chinese side.

"The $200 billion we’re talking about could take place very soon, depending on what happens with them. To a certain extent, it’s going to be up to China. But we’ve taxed them $50 billion — that’s on technology. Now, we’ve added another $200 billion. And I hate to say this, but, behind that, there’s another $267 billion ready to go on short notice, if I want. That totally changes the equation," Trump told reporters aboard Air Force One at the weekend.

The US alleges China uses "unfair" trading practices that, among other things, force American companies operating in the country to hand their intellectual property over to Chinese companies. Combating these practices was a key part of President Trump's electoral campaign offering and is among a range of issues that he has long spoken out against.

Fears the tariff fight will dent economic growth the world over have been growing within the analyst community in recent months. And some have been quick to play down the importance of Wednesday's report of fresh talks between the US and China.

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