The stealthy 2023 economic boom

Remember all that recession talk last year? Nevermind.

• The U.S. economy roared into 2023, with January's exceptionally strong retail sales number, out this morning, serving as the latest evidence.

Why it matters: The strength — across consumer spending, the job market and inflation — to start the year muddles the outlook for how high the Federal Reserve may ultimately have to raise rates.

• It heightens odds that the central bank will end up tightening the screws more than it has been signaling.
• Reflecting that possibility, the yield on a six-month Treasury security surged above 5% this morning for the first time since 2007.

Driving the news: Retail sales rose 3% in January, the Census Bureau said, reversing November and December's back-to-back declines. Consumers spent more in every single category the government tracks — except gasoline stations, where sales were flat.

• Importantly, the component that feeds into GDP calculations — retail sales excluding autos, building materials and gasoline — surged 1.7% in January.
• Economists at JPMorgan raised their Q1 GDP projection to 2%, from 1%, on the news.

Yes, but: The apparent strength of the retail sales data is exaggerated by seasonality quirks — namely, consumers shifting their buying patterns to include less of a surge during the holidays and therefore less of a pullback in January.

The big picture: The Fed wants to see the economy continue to cool off, but the data flow in recent days suggests the opposite. The big question is whether that means officials will start to consider raising rates higher than the 5.1% that was their consensus view in December.

What they're saying: In a note Tuesday, Deutsche Bank chief U.S. economist Matthew Luzzetti and several colleagues wrote that three things have become clear since the Fed's last policy meeting two weeks ago.

• "First, the labor market is so far remarkably resilient to Fed tightening," they wrote.

• "Second, less progress has been made towards disinflation" given Tuesday's inflation numbers.
• Third, financial conditions have failed to tighten enough for the Fed to have confidence that these first two trends will improve meaningfully in the coming months."

For those reasons, the Deutsche Bank economists have increased their forecast for the "terminal rate" of the Fed's target to 5.6%, from 5.1%.

What's next: Data on jobs and inflation for February, due out in early March, will shed some light on how much of the January boom was an artifact of seasonal adjustment.

• Either way, when the Fed releases a new set of economic projections —including for its target interest rate — it will be fascinating to learn if officials see a need to change their plans by pushing rates higher.