While often overshadowed by major economic indicators like the Consumer Price Index (CPI) inflation and job market reports, retail sales data could play a pivotal role in the Federal Reserve’s upcoming interest rate decision. This Tuesday’s release of August retail sales figures arrives just before the Fed’s two-day Federal Open Market Committee (FOMC) meeting, where a crucial interest rate decision is scheduled for Wednesday.
While a rate cut is widely anticipated, the extent of the reduction remains uncertain. Market projections currently favor a 50-basis-point cut with a 60% probability, while a more modest 25-basis-point reduction holds a 40% chance, according to the CME FedWatch tool.
Stephen Juneau, an economist at Bank of America, believes that recent economic data doesn’t justify a large rate cut. However, he acknowledges that a significantly weak retail sales report, particularly a decline of -1% or worse, could prompt the Fed to consider a substantial rate cut. Bank of America forecasts a 0.3% monthly decline in overall retail sales, a more pessimistic outlook compared to the Bloomberg consensus predicting a 0.2% increase.
The investment bank emphasizes the unprecedented level of uncertainty surrounding this FOMC meeting, comparable to the market volatility seen in 2015. Analysts highlight that the market’s indecision regarding a 25-basis-point or 50-basis-point cut will likely make the meeting a catalyst for trading activity. To guide investors through this period of market uncertainty, Bank of America has presented a matrix outlining potential investment strategies based on the combination of retail sales figures and the Fed’s stance.
If retail sales show strong growth and the Fed adopts a dovish approach, investors are advised to invest in cyclical stocks. However, if sales are weak and the Fed leans towards a hawkish stance, a shift towards defensive stocks may be more prudent.
Bank of America notes that rate-sensitive sectors like manufacturing and housing have been negatively impacted by the Fed’s previous rate hikes. The ISM Manufacturing PMI has been struggling, posting two consecutive months above 50 for the first time in 23 months, highlighting the second-longest slump on record. Similarly, the housing market has seen existing home sales decline by nearly 40% year-over-year, reaching their lowest point.
The investment bank believes that easing rate pressure should lead to a moderate recovery in manufacturing and housing activities, potentially boosting earnings growth for the S&P 500 into 2025. In light of this optimistic view, analysts recommend overweighting sectors that are likely to benefit from reduced rate pressure, including Financials, Consumer Discretionary, Real Estate, and Utilities.
Earlier this month, the investment bank upgraded Utilities, as represented by the Utilities Select Sector SPDR Fund XLU, from Market-Weight to Overweight, reflecting a more bullish outlook on high-quality, income-generating companies within the sector.
The upcoming retail sales data will be a key factor in shaping the Federal Reserve’s interest rate decision, with the potential to influence the direction of the market in the coming weeks and months.
