Sunday, 15 February 2015

Petrol Prices and the J-Curve Impact on US Retail

They key shock of the week was the 0.8% mom fall in January’s total retail sales, or 0.9% if you exclude autos. How much of this was simply a reflection of lower gasoline prices, and if gasoline prices are responsible for the fall, what is the future trajectory of retail sales likely to be over the coming months? Gasoline prices and gasoline sales were the key to the whole retail slowdown in January. Sales at gasoline stations fell 9.3% mom sa, which is hardly surprising given that the average price of regular unleaded fell by 11.3% mom. Excluding gasoline sales (and autos), sales rose 0.2% on the month. On a 3ma basis, sales excluding autos are falling sharply averaging a 0.5% mom fall, but excluding gasoline, sales growth is running at 0.3%, dipping very slightly from the average run-rate of 0.4% which has been seen since 2011.

Consumption of goods accounts for 23% of US GDP, so at first sight this slowdown threatens growth. But since falling petroleum prices have been responsible for almost all of the slowdown of the last few months, the deflators will take care of that impact as far as GDP growth is concerned. The key word, however, is 'almost': beyond the simple price impact on the headline nominal numbers, the sudden fall in petroleum prices - down 25% since September - has another less obvious effect on consumer behaviour.  If the fall in gasoline prices is experienced as an unexpected windfall by the consumer, one would expect an initial phase in which the fall in prices is an unexpected windfall which initially (and inadvertently) saved,  only to be spent subsequently when the consumer adjusts to his/her new and larger budget.  In other words, one would expect a ‘J-curve’ effect.

Is this happening? The first crucial question to be addressed is: at what point would one expect the fall in gasoline prices to  take consumers by surprise?.  If the answer to this is: ‘when it falls significantly below the range recently experienced, then this is not difficult to spot. The chart below shows a fairly clear range sustained between January 2011 and October 2014, in which the price of regular conventional gasoline averaged $3.48 a gallon, with a standard deviation of 20 cents. In this chart the dotted lines show the two standard deviation level, which at the lower boundary comes out at $3.07 a barrel. One might speculate that above this level, the consumer would be unlikely to react to price fluctuations, but when it dived sharply below that, it represents a clear break from recent experience. According to Energy Information Administration that happened only in the last week of October. So it is only in November, and more obviously in December that one would expect any J-curve effect to be developing.

How big an impact? In the year to September, spending on petroleum accounted for 13% of retail sales (ex autos): a 25% fall in prices since then therefore amounts to a windfall gain equivalent to 3.3% of the retail budget.  This windfall looks to have been unexpected and to have been saved in December at least, when, reversing a decline in the trend visible since the middle of the year, the savings rate jumped 0.6pps to 4.9% in December (vs 4.1% in Dec 2013).  We should expect to see a similar or even higher rate in January.

But later, that savings rate is likely to retreat again as households adjust their spending to their newly-expanded budget. When petroleum prices stabilize, so will that portion of retail sales. Meanwhile, as consumers adjust their spending to reflect the new lower petroleum prices the personal savings rate falls and ex-petroleum sales accelerate beyond the current 0.3% mom run-rate, and probably, for a while, beyond the longer-term 0.4% rate. Looking back, we will see the J-curve effect at work.

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