With the Federal Reserve, ECB and BoE interest rate decisions behind us, forex traders will have their eyes glued to the screen for tomorrow?s US retail sales and producer price reports. Consumers have long been the backbone to a rather withering US economy.
The housing market has recently shown signs of buckling while growth in the first quarter slipped to a sub par rate of 1.3 percent from 2.5 percent in the fourth quarter. As a result, the Federal Reserve is heavily counting on the resilience of the consumer in supporting the expansion, helping to stabilize the 5.25 percent interest rate, and of course the US dollar. But what has changed? Notably, crude prices have picked back up on supply concerns ahead of the heavy summer driving season. Even more surprising has been the advance of gasoline prices. Higher prices at the pump mean less dollars in the pocket of US consumers, which in itself spells slower times for the US. If you were just watching the price of crude rather than the price of retail gasoline, you may have never been able to tell that US consumers are facing some serious pain, which could be reflected in tomorrow?s retail sales figure. A weak number could put a dent into the latest dollar rally.
Understanding the Divergence in Gas And Oil
Traditionally, the main determinant of the price of gasoline in the United States is the price that crude oil settles at on the New York Mercantile Exchange. However the fact of the matter is that gasoline is produced in oil refineries and separated from crude oil via a process called distillation. This may explain why in the past month, gasoline prices have been decoupling from the world’s most actively traded commodity.
In the chart below, we plotted the USA average of gasoline prices against oil contracts using Gasbuddy.com. .Looking at price action of the past 2 months, one can see that while oil prices have remained range bound, gasoline prices have been skyrocketing.
A number of factors have combined strengths to push the price of gasoline in a different direction from crude oil, but we believe one reason alone has been the key behind such a big divergence. The United States spends nearly 360 million gallons of gasoline every day and many refineries are struggling to keep up with the demand. Refineries are running near full capacity and as a result the United States has become more dependent on imported gasoline. The main setback for the US consumer is that imported gasoline is normally more expensive and prices fluctuate according to international oil prices. The main reason why gasoline prices are decoupling from oil prices is that the popular West Texas Intermediate has diverged significantly in price from other grades of crude oil traded all over the world. For example, a barrel of North Sea Brent crude traded on the ICE Futures exchange costs $64.59, nearly $5 more than a light sweet crude oil barrel. In the past, Brent Crude futures have been priced relatively higher than WTI futures but only at a premium that ranges from $1 to $3 per barrel.
What Does This Mean for PPI and CPI?
Over the past few years, constant media coverage and cross market investing have left crude oil the benchmark for overall energy activity. While this may be sufficient for those looking for the general direction and conditions in specific petroleum-based markets like natural gas, gasoline or crude; it can be a detriment when this oversimplification is used for more precise tasks - like speculating on producer or consumer prices . In today?s currency market, low volatility and high returns have sent traders to seek out yield through the passive carry trade. For some time, one of the primary target currencies (the high-yielding currency purchased in the carry trade) has been the US dollar; though its appeal has waned since the Fed put the stopper in its steady stream of rate hikes and slowing growth trends have raised expectations of a possible cut. This has only increased the influence the price gauges have on monetary policy and the market since the threat of a resurgence in inflation has been labeled the Federal Open Market Committee?s predominate concern? and may very well be the only thing keeping interest rates at current levels.
What?s more, the divergence in crude and gasoline prices can actually create variations between the price gauges. Since PPI comes out on Friday and CPI on Tuesday, traders typically use the earlier released numbers to speculate on the ones printed later. The government statistics body releases its three price indicators in the order of: Import Price Index; Producer Price Index; Consumer Price Index. Coincidence or not, this schedule arranges the indices from the one most heavily influenced by crude prices to the one that affords the greatest weighting to gasoline prices. To start off, the United States refines most of its own gasoline; so crude imports account for a greater portion of the IPI. Moving along, factories produce refined and unrefined fuels to sell to distributors and other business as well as consumers. Finally, at the end of the line, the CPI is a basket that encompasses goods that consumer purchase; so gasoline inflation clearly overrides everything else. Given these unique set of circumstances, speculation that normally builds up behind the Consumer Price Index could be put on the wrong path early.
Retail Sales Negative?
So what?s this all mean? Gasoline prices have now increased to record levels and is advancing by a rate faster than current inflation, which leaves consumers little in the way of spending money, Right now, overall average price increases are moving at a 2.7 percent pace, compared to an annualized increase of 5 percent on the average tank of gas. Last year at this time, nationwide gasoline prices averaged $2.90 compared to $3.07 two days ago. Even more depressing is the fact that price were at an average of $2.74 just a month ago before the pre-summer surge occurred. Therefore higher prices at the pump may in fact be crimping retail sales figures, not seasonal doldrums. According to preliminary government expectations, colder weather, lots of snow and rain, and an earlier Easter holiday may be what?s to blame for the first retail sales dip in four years. However, with rising gasoline prices, the same consumers may not be so eager to spend as they have to stretch their last dollar. Not to mention the fact that it now costs 5 percent more to drive to the malls. The absence of any real demand at the retail level has left major shops looking to mark down their inventory in hopes of attracting short term interest. However, the results have been lackluster, leaving bellwethers like Wal-Mart and Ann Taylor to report below expectations. Just recently, the world?s first ranked retailer, Wal-Mart Stores Inc., reported to the low side of expectations. According to the Bentonville, Arkansas based company, April sales fell 3.5 percent (a 27-year worst). Significant declines in other notable companies, including Federated Department Stores Inc. and Gap Inc., were witnessed. Gap Inc. saw significant plunges in same store sales. The largest clothing retailer in the US reported a whopping decline of 16 percent in store sales. Overall significantly softer than expected, the massive drop offs in weekly consumer demand will weigh heavily on the monthly figure.
With higher gasoline prices, consumer retail tend to decline in the short term. The effect has become increasingly profound over the last year. (Data Provided by Bloomberg Professional Service, Prepared by David Rodríguez)
Adding everything up the outlook for the retail sales number seems pretty gloomy for the overall headline report as the market is looking for the US Commerce Department to produce a miniscule 0.4 percent rise in consumer spending the month of April. Excluding the transportation component, the core figure is also expected to decline slightly, dropping to an advance of only 0.5 percent after a rise of 0.8 percent in the month. As for producer prices, the market is expecting headline prices to rise by a more modest 0.6 percent and for core prices to grow by 0.2 percent. Softer numbers will keep the specter of a rate cut looming over the dollar, crimping any hope for a longer term appreciation heading into the summer months. Stronger ones of course will exacerbate the current dollar strength.