The inflation monster never appeared in 1994 despite all the sightings of its shadow. That was particularly true for apparel. Prices ended 1994 down sharply. But as economic expansions mature across the globe, nonapparel prices will finally be pushed higher in 1995. That could mean more interest rate hikes by the Federal Reserve Board in 1995. However, the board's inflation-fighting zeal will be tempered by fears of pushing more financial institutions into problems like those in Orange County, Calif., and more developing countries like Mexico into liquidity problems of their own. For apparel retailers, the outlook means slower consumer spending. The housing market will slow, but not plummet. Spending on hard goods will come down. Inflation will accelerate mildly, making it easier to pass on price increases. Apparel retailers will be left out of this inflation cycle because inventories remain abundant and consumers are still value conscious. Lurking Shadows All consumer prices for 1994 were up only 2.7%. Producer prices for finished goods were up modestly in 1994. During this economic expansion, U.S. industries have imported an increasing share of the supplies and materials used in production. As the U.S. economy has become more entwined in the global economy over the past five years, the old indicators of inflation and an overheated economy are not as reliable as they used to be. What kept inflation down was the decline in growth overseas. U.S. industrial production has been on a constant rise since early 1991, and industrial production in Europe, Germany and Japan has been in a steady decline. Global Expansion With slack worldwide demand, imports of supplies into this country have occurred with little inflation. So even though capacity utilization is hitting new highs, the bottlenecks and shortages that appeared in mature expansions of the past were ameliorated by improved global supplies today. The global markets have acted as an escape valve for inflationary pressures within the U.S. economy. But that valve is about to close. Industrial production in Europe, Germany and Japan bottomed out early this year and has begun to rise. GATT will stoke the recoveries. As these global expansions pick up steam in 1995, competition for scarce resources worldwide will translate into higher production costs and inflation. These global recoveries will not just mean inflation. U.S. exporters will benefit, particularly the strong export regions on the Pacific coast and in the Midwest. The Tempered Fed All this makes the issue of more interest rate hikes a question of when and how much. Another hike would be timely to shore up the value of the dollar and dampen the expected increase in global demand. But the question of when and how much has become all the more critical in light of the financial disaster in Orange County California. Orange County was just the most recent evidence that financial markets became comfortable with betting that interest rates would continue to fall--or surely not rise as quickly as they did. The steep rise in interest rates this year has also produced losses in the millions in public investment portfolios in Maryland, Ohio, Texas and West Virginia. But those are just the public examples. Many banks have suffered millions of dollars in unrealized losses from portfolios with interest-sensitive securities. These are the portfolios that banks built up in the aftermath of the savings and loan crisis when federal regulators cracked down on lending practices. Instead of making loans, banks put their money into the bull market in bonds. The last thing the Fed wants is an interest rate hike that precipitates a crisis in the U.S. financial system. The last recession illustrated the powerful contractionary effects of a sick banking system. It has been only since the start of this year that banks have expanded their loan making, particularly to small- and medium-sized companies. That renewed loan making is a big part of what's fueling the growth in the economy today. As a result, the next interest rate hike will have to be measured and timed with an eye toward its impact on the banks. That means the Federal Reserve might hit the interest rate button more slowly and not as hard. Tax Cuts Anyone? The race in Washington to cut taxes for the middle class will be an important factor in 1995. If nothing else, the changing course in Washington will create uncertainty. Give the middle class a tax cut and they have shown time and again that they will go out and spend it. A capital gains tax cut is also a possibility, proving that the Democrats can deliver a windfall to the wealthy just as effectively as the Republicans have in the past. The Democrats are likely to use dynamic scoring, a topic President Clinton would seem to know something about, at least anecdotally, when it comes to accounting for the capital gains tax. Through the magic of dynamic scoring, cuts in capital gains taxes show up as increases in tax revenue. Both political parties will be under extreme pressure to make sure that any tax cut is paid for with spending cuts. You can bet that the tax cuts will come first, while the spending cuts will come later. What It Means For Retailers With interest rates coming down and a tax cut putting more money in the pocket of the consumer, the outlook for consumer spending in general and apparel spending in particular is modestly positive. With unemployment hitting lows not seen since the 1960s, the real challenge for all retailers will be finding good quality workers at a reasonable cost.
Hermès is launching a Laundromat pop-up shop in NYC - dubbed Hermèsmatic - where customers can bring their old scarves to be dip-dyed by an expert. Get all the details on WWD.com. #wwdnews (📷: @donstahl)