Tuesday's retail sales report for August indicates that the U.S. economy is doing pretty well, but the Federal Reserve is still expected to cut rates on Wednesday to avoid making the same mistakes as one of its predecessors, an economist says.

"If the Fed doesn't initiate its easing cycle with 50-basis points surely a 25-basis point move will be enveloped by a dovish tone and offers the Fed the flexibility and gradualism in the event inflation remains even slightly elevated," said Quincy Krosby, chief global strategist for LPL Financial.

"Make no mistake about it, Chair Powell doesn't want at any level to be branded a latter-day Arthur Burns and perhaps that's what motivates the Fed's direction tomorrow."

Burns, America's 10th Fed chairman from 1970 to 1978, has been remembered for letting inflation run rampant.

The strategist said that while retail spending "remains on solid footing," the Fed has to consider how its higher-for-longer approach on rates has put pressure on lower-wage earners and lower-middle-income workers.

"Small business owners similarly have been dealing with bank loans reflecting higher rates," she said.

Retail Takeaways

Retail sales in the U.S. improved more than forecasted by 0.1% month-over-month in August but ebbed considerably from July's upwardly revised growth, making the case for a smaller interest rate cut when the Federal Reserve meets on Wednesday.

  • Retail sales rose 0.1% month-over-month in August, exceeding TradingEconomics' consensus of a 0.2% decline.
  • July's retail sales growth was upwardly revised from 1% to 1.1%.
  • Year-over-year retail sales slowed from the upwardly revised 2.9% in July to 2.1% in August.
  • Excluding motor vehicles and parts, sales grew by 0.1% from July to August to come in below July's 0.4% growth and an forecasted 0.2% uptick.
  • After taking out gasoline, motor vehicles and parts, sales rose by 0.2% from July to August, easing from the 0.4% gain in July and under the expected 0.3%
There is a 67% chance of a 50-basis-point rate cut, compared to a 33% likelihood of a smaller 25-basis-point cut, according to the CME FedWatch Tool.

The Fed is "dealing with mixed signals" as they face Wednesday's rate-cut decision as the economy shows resilience despite early signs of labor market weakness, said Jeffrey Roach, chief economist for LPL Financial.

"The Fed may end up falling behind the curve again if they rely too much on stale data and not enough on the forward-looking outlook."

The drop in gas prices in August and September is boosting consumer sentiment and should boost spending on other goods and services, said Bill Adams, chief economist for Comerica Bank.

"Consumer spending is holding up in aggregate, held up by higher income households whose spending is less affected by month-to-month changes in the cost of a dozen eggs or a gallon of milk," he said.

"Another cohort supporting the economy is Americans who own the same houses they lived in in 2021, 2014, or 2004. They are much less affected by shelter inflation than renters or those who've bought more recently," Adams added.