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Weekly Update 05/31/2024: US Inflation Moderates in April

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Domestic Economic News

The Federal Reserve’s preferred measure of underlying US inflation moderated in April and consumers dialed back their spending, supporting plans for an eventual reduction in interest rates. The so-called core personal consumption expenditures price index, which strips out the volatile food and energy components, increased 0.2% from the prior month. That marked the smallest advance of the year, according to Bureau of Economic Analysis data out Friday. Inflation-adjusted consumer spending unexpectedly fell 0.1%, dragged down by a decrease in outlays for goods and softer services spending. Wage growth, the primary fuel for demand, moderated. The report offers Fed officials some solace about the pathway for inflation after progress on price pressures was interrupted in the first quarter. At the same time, the April spending figures add to evidence that the year is off to a slow start for the economy. Treasury yields moved lower and S&P 500 index futures gained, while the dollar index declined. Swaps traders still expect the Fed to cut rates at least once this year. Central bankers have been increasingly squinting their eyes when looking at inflation data in an effort to make the most adequate policy decisions in what continues to be an uncertain economic scenario. On a three-decimal basis, the core metric rose 0.249% from March, the smallest advance this year. “I look forward to the day when I don’t have to go out two or three decimal places in the monthly inflation data to find the good news,” Fed Governor Christopher Waller said last week. Central bankers pay close attention to services inflation excluding housing and energy, which tends to be more sticky. That metric climbed 0.3% after rising 0.4% in March, according to the BEA.

Meanwhile household demand, while fueled by steady job and income growth, is showing signs of cooling. The BEA’s report showed inflation-adjusted outlays for services rose 0.1%, the smallest gain since August. Spending on merchandise decreased 0.4% last month. Goods outlays were restrained by declines in gasoline and vehicle purchases. While health care spending supported outlays for services, other categories such as restaurant meals, recreation and transportation decreased during the month. Looking ahead, with household debt hitting a record, consumer confidence generally trending lower and interest rates at a two-decade high, it remains to be seen to what extent consumers will continue powering the economy. While demand for workers is still healthy, the pace of wage growth is cooling. Overall incomes rose 0.3% in April. Wages and salaries advanced 0.2%, the smallest gain in five months. The details of April’s report are favorable as the Fed looks for signs that underlying inflation pressures are waning. Still, we expect the Fed to stay on hold at the June meeting as it awaits additional data that can boost its confidence inflation will cool.

The US economy grew at a slower pace in the first quarter than initially reported, primarily reflecting softer consumer spending on goods. Gross domestic product rose 1.3% annualized in the first three months of the year, below the previous estimate of 1.6%, Bureau of Economic Analysis figures published Thursday showed. The economy’s main growth engine — personal spending — advanced 2.0%, versus the previous estimate of 2.5%. The numbers underscore a loss of momentum to start 2024 after continual upside surprises in 2023. High interest rates, waning pandemic-era savings and slower income growth are some of the key factors weighing on American households and businesses. Consumer spending was marked down as outlays for goods — particularly autos — were much softer. Federal government spending slowed, while imports picked up compared to the first estimate. Net exports subtracted from growth for the first time in two years. The downward revision to consumer spending was partially offset by stronger business and residential investment. A key measure of underlying domestic demand known as final sales to private domestic purchasers rose 2.8%, versus the initially reported 3.1% increase. Economists have pointed to the strength in this metric as reason to believe that demand is still strong, even if the headline GDP figure looks weak by comparison.

Alongside its second estimate of GDP, the BEA also publishes data on gross domestic income, its other main measure of economic activity. GDI rose 1.5% in the first quarter, according to the report. GDP measures spending on goods and services, whereas GDI measures income generated and costs incurred from producing those same goods and services. The GDI data include figures on corporate profits. In the first quarter, adjusted pre-tax profits fell 0.6%, the first decline in a year. After-tax profits as a share of gross value added for non-financial corporations, a measure of aggregate profit margins, were little changed at 15.2%. On the inflation front, the Federal Reserve’s preferred metric — the personal consumption expenditures price index — rose at a 3.3% annualized rate in the first quarter, slightly down from the initial projection. Excluding food and energy, the core PCE gauge rose 3.6%, versus 3.7% in the previous estimate. Growth in disposable personal income was marked up to 1.9% versus 1.1% initially. That may bode well for consumer spending and GDP going forward. Meantime, initial applications for unemployment benefits were little changed in the latest week at low levels. Jobless claims ticked up at the end of May, though the level remains low. With hiring intentions from regional Fed surveys remaining negative, the unemployment rate could increase ahead. Anecdotes in the latest Beige Book noted businesses are pulling back on hiring expectations due to weaker demand and the uncertain economic environment. * Initial claims for unemployment insurance for the week ending May 25 increased to 219,000 (vs. an upwardly revised 216,000 prior) — above the consensus forecast (217,000). The combination of weaker growth and higher claims sent yields lower across the Treasury curve in Thursday trading.

US consumer confidence unexpectedly rose in May for the first time in four months as views about business conditions and the labor market were less negative. The Conference Board’s gauge of sentiment increased to 102 from an upwardly revised 97.5 in April, according to data out Tuesday. The reading beat all estimates in a Bloomberg survey of economists. May’s index of present conditions climbed for the first time since January and the measure of expectations jumped by the most since July. Despite the increase, confidence has trended lower in recent months as inflation has remained mostly stubborn, household debt hit a record and the job market has softened. And with the Federal Reserve keeping interest rates at a two-decade high, voters are generally downbeat on the economy ahead of November’s election. That was especially illustrated in Tuesday’s report as consumers’ perceived likelihood of a recession in the next year rose for a second consecutive month. The views on the labor market, business conditions and the stock market were rare relative bright spots in a report that otherwise showed consumers are increasingly worried about rising prices and their family’s financial situation. Consumers appeared more concerned about inflation, with the average expected rate rising to the highest this year. “According to May’s write-in responses, consumers cited prices, especially for food and groceries, as having the greatest impact on their view of the US economy,” Dana Peterson, chief economist at the Conference Board, said in a statement. Americans’ view of the labor market were mixed — while fewer consumers said jobs were “plentiful,” a smaller share said jobs were “hard to get.” The difference between these two — a metric closely followed by economists to gauge labor-market strength — edged higher. The future outlook for the job market was less pessimistic as near-term income prospects improved.

US mortgage rates increased for the first time in a month, denting demand for home-buying and refinancing. The contract rate on a 30-year fixed mortgage increased 4 basis points in the week ended May 24 to 7.05%, according to Mortgage Bankers Association data released Wednesday. That dragged down a gauge of refinancing by more than 13%, while purchasing activity fell to the lowest level in three months. Mortgage rates move in tandem with Treasury yields, which rose last week as economic data showed strength in US business activity and a tight labor market. That prompted traders to push back their expected timing for Federal Reserve interest-rate cuts until the end of this year. The MBA survey, which has been conducted weekly since 1990, uses responses from mortgage bankers, commercial banks and thrifts. The data cover more than 75% of all retail residential mortgage applications in the US.

A gauge of pending US existing-home sales tumbled to a four-year low in April as higher mortgage rates cast a pall on the spring selling season. An index of contract signings from the National Association of Realtors dropped 7.7% to 72.3, the lowest reading since the early months of the pandemic. The monthly decline was steeper than all estimates in a Bloomberg survey of economists and the worst since February 2021. All regions of the US saw decreases from a month earlier. “The impact of escalating interest rates throughout April dampened home buying, even with more inventory in the market,” NAR Chief Economist Lawrence Yun said in a statement. “But the Federal Reserve’s anticipated rate cut later this year should lead to better conditions, with improved affordability and more supply.” Contract closings on previously owned homes have been stuck near the annualized 4 million mark for more than a year as buyers struggle with high prices and mortgage rates near 7%. At the same time, sellers are reluctant to give up mortgages carrying much lower rates. Sales were well over 6 million a year at the height of the pandemic-era buying spree in fall 2020. New data suggest buyers aren’t getting any relief on costs, either. Prices in 20 major US cities actually picked up the pace in March, rising 7.4% from a year ago, according to a S&P CoreLogic Case-Shiller index. Price increases should finally taper off when more inventory hits the market, Yun said in a release Thursday, although for now, the 1.2 million homes on the market are well below prepandemic levels. “The prospect of measurable home price declines appears minimal,” Yun said. “The few markets experiencing price declines will be viewed as second-chance opportunities for buyers to enter the market if those regions continue to add jobs.” While many are awaiting a move by the Fed to cut interest rates, officials are widely expected to keep rates at a 23-year high at their next meeting in June. The Midwest saw the biggest drop in pending sales, down 9.5% in April, followed by declines of 8.5% and 7.6% in the West and South, respectively. Contract signings in the Northeast fell 3.5%. The pending-sales report tends to be a leading indicator of sales of previously owned homes, because houses typically go under contract a month or two before they’re sold.

Interst Rate Insight and the Fed

A selloff in the world’s biggest bond market dragged down stocks in Tuesday trading, with traders also weighing mixed economic data and remarks from Federal Reserve speakers for clues on the outlook for interest rates. Treasuries extended losses after the US sold $70 billion of five-year notes at 4.553% — above the pre-auction level of 4.540%. An earlier offering of $69 billion in two-year notes also came on the soft side. Just a few days before the Fed’s favorite price gauge, a report showed US consumer confidence unexpectedly rose in May — though recession expectations increased as well. Investors also waded through remarks from Fed Bank of Minneapolis President Neel Kashkari, who said the policy stance is restrictive, but officials haven’t entirely ruled out additional rate hikes. Swap contracts are currently pricing in around 30 basis points of Fed rate cuts for all of 2024 — which equates to one reduction as the Fed moves have historically been increments of 25 basis points. As we frequently say here at SGK, stay tuned!

Federal Reserve Bank of Atlanta President Raphael Bostic said he’s hopeful that the “explosive” price pressures seen during the Covid-19 pandemic will normalize over the next year. Speaking at a conference in Atlanta on Wednesday, Bostic said “we still have a ways to go” to curb the significant price growth seen over the last few years. While the breadth of inflation is still quite high, he said a reduction in that breadth would help him gain the confidence needed to cut interest rates. “My outlook is that if things go according to what I expect — inflation goes slowly, the labor market slowly and orderly moves back into a sort of a weaker stance, but a stable-growth stance — I’m looking at the end of the year, the fourth quarter, as the time where we might actually think about and be prepared to reduce rates,” Bostic said. The Atlanta Fed chief said many of the different measures of inflation he looks at on his dashboard “are moving back into the target range.” The US economy expanded at a “slight or modest” pace across most regions and consumers pushed back against higher prices since early April, the Fed said in its Beige Book survey of regional business contacts, published Wednesday. Fed officials have held rates in a range of 5.25% to 5.5%, a two-decade high, since last July. A series of policymakers have indicated they need to see more data to become confident that inflation is set to return to the central bank’s 2% target. Bostic votes on the policy-setting Federal Open Market Committee this year, which meets next on June 11-12.

In more FedSpeak out this week, Federal Reserve Bank of New York President John Williams said he expects inflation to continue falling in the second half of this year, adding that elevated borrowing costs are restraining the economy. Williams said that while inflation is still too high, Fed policy is well positioned and the imbalances between supply and demand are easing. “With the economy coming into better balance over time and the disinflation taking place in other economies reducing global inflationary pressures, I expect inflation to resume moderating in the second half of this year,” Williams said Thursday in prepared remarks at the Economic Club of New York. “The behavior of the economy over the past year provides ample evidence that monetary policy is restrictive in a way that helps us achieve our goals,” he said, adding later that a rate increase is unlikely. In a moderated conversation following his remarks, Williams said he couldn’t say when he’d be likely to support a rate cut, emphasizing it depended on what incoming data told him about the economy. “I don’t feel any urgency or need that we have to make a decision now,” he said. Williams said he didn’t view recent price data as a sign that inflation is no longer heading lower. Williams said earlier this month that monetary policy is in a good place and he wants to see more evidence to be confident inflation is falling to the central bank’s target.

Impactful International News

German inflation quickened for a second month – underscoring the task for the European Central Bank to achieve its 2% target as it prepares to lower interest rates next week. Consumer prices rose 2.8% from a year ago in May, the statistics office said Wednesday. That’s up from 2.4% in April and above the 2.7% median estimate in a Bloomberg poll of economists. The uptick was largely driven by base effects related to the introduction of a cheap public-transportation ticket, which pushed prices down 12 months ago. This week’s numbers are unlikely to deter ECB policymakers from reducing borrowing costs on June 6 for the first time since an unprecedented barrage of hikes was deployed to tame runaway price gains. But they may make officials more hesitant on subsequent moves. Hawks like Executive Board member Isabel Schnabel and Bundesbank President Joachim Nagel recently warned against loosening monetary policy too rapidly and back-to-back steps in June and July. But France’s Francois Villeroy de Gahau said Monday that the ECB shouldn’t rule out such a scenario. Investors have pared cut bets in the wake of unexpectedly strong first-quarter wage data and surveys signaling healthy private-sector economic activity. They now only fully price two quarter-point reductions in 2024 — down from three before. Germany saw particularly robust pay increases at the start of the year. Negotiated wages surged by 6.2% from a year earlier, compared with 4.7% for the entire euro area. In a report last week, the Bundesbank said inflation probably gathered pace in May, predicting it will “fluctuate at a slightly higher level over the next few months.” Wage growth “has exceeded expectations of late, which could mean that the still high price pressure in services will persist for longer,” it said. While Germany’s statistics office doesn’t publish a core-inflation reading in its preliminary release, regional data suggest an advance to 3.2% from 2.9% in May, according to Bloomberg Economics, which nevertheless sees disinflation resuming in the coming months.

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