Weekly Update 02/17/2023: Inflation Remains Sticky According to Latest CPI & PPI Reports

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Domestic Economic News

US consumer prices rose briskly at the start of the year, a sign of persistent inflationary pressures that could push the Federal Reserve to raise interest rates even higher than previously expected. The overall consumer price index climbed 0.5% in January, the most in three months and bolstered by energy and shelter costs, according to data out Tuesday from the Bureau of Labor Statistics. The measure was up 6.4% from a year earlier. Excluding food and energy, the so-called core CPI advanced 0.4% last month and was up 5.6% from a year earlier. Economists see the gauge as a better indicator of underlying inflation than the headline measure. The median estimates in a Bloomberg survey of economists called for a 0.5% monthly advance in the CPI and a 0.4% gain in the core measure. The S&P 500 opened lower and Treasury yields rose. Traders also priced in near-even odds of a quarter-point Fed rate increase in June as well as a higher peak rate. Both annual measures came in higher than expected and showed a much slower deceleration than in recent months. The figures remain far higher than the Fed’s 2% target, which is based on a separate Commerce Department index.

The figures, when paired with January’s blowout jobs report and signs of enduring consumer resilience, underscore the durability of the economy — and price pressures — despite aggressive Fed policy. The data support officials’ recent assertions that they need to hike rates further and keep them elevated for some time, and possibly to a higher peak level than previously expected. The path to stable prices will likely be both long and bumpy. The goods disinflation that has driven the slide in overall inflation in recent months appears to be losing steam, and the strength of the labor market continues to pose upside risks to wage growth and service prices. The details of the report showed shelter was “by far” the largest contributor to the monthly advance, accounting for almost half of the rise. Used car prices — a key driver of disinflation in recent months — fell for a seventh month. Energy prices rose for the first time in three months. Shelter costs, which are the biggest services component and make up about a third of the overall CPI index, rose 0.7% last month. Owners’ equivalent rent and rent of primary residence increased by the same amount, while hotel stays also climbed. Because of the way the housing metrics are calculated, there’s a significant lag between real-time price changes and the government statistics. The January report incorporated new weights for the consumer basket to try to more accurately capture Americans’ spending habits. The shelter components are now a larger share of the overall index while used cars make up a smaller portion.

US retail sales rose in January by the most in nearly two years, signaling robust consumer demand that could bolster the Federal Reserve’s resolve to keep raising interest rates in the face of persistent inflation. The value of overall retail purchases increased 3% in a broad advance — the most since March 2021 — after a 1.1% drop in the prior month, Commerce Department data showed Wednesday. Excluding gasoline and autos, retail sales rose 2.6%, also the biggest increase in nearly two years. The figures aren’t adjusted for inflation. The total retail sales figure matched the highest estimate in a Bloomberg survey of economists, which had a median forecast of 2%. All 13 retail categories rose last month, led by motor vehicles, furniture and restaurants. The report showed vehicle sales climbed 5.9% in January, also the most in nearly two years. The value of sales at gasoline stations were essentially unchanged. The report showed US consumers got off to a good start in 2023, rebounding from a spending slowdown at the end of last year. A resilient labor market marked by historically low unemployment and solid wage gains has allowed many Americans to keep spending on goods and services even as borrowing costs rise and inflation remains elevated.

Output at US factories rose in January by the most in nearly a year, suggesting improving supply chains and firmer demand are offering some relief for a still-challenged manufacturing sector. The 1% increase last month in factory production — the most since February 2022 — followed a downwardly revised 1.8% decline in December, according to Federal Reserve data released Wednesday. Including mining and utilities, total industrial output was unchanged in January, restrained by unseasonably warm weather that depressed demand for heating. The median forecast in a Bloomberg survey of economists called for a 0.8% increase in manufacturing production and a 0.5% gain in total output. The increase marks a welcome respite for factories who dialed back output significantly during the final two months of last year in the face of softer demand. While separate data Wednesday showed a sharp rebound in retail sales in January, manufacturers still face a number of headwinds that include a tepid global economy, elevated inventory levels and risks of a pullback in capital investment as interest rates rise. The figures stand in contrast with survey data from the Institute for Supply Management that showed a gauge of factory activity shrank for a fifth month to the lowest level since May 2020. The Fed’s report also showed capacity utilization at factories rose to 77.7%. In December, the capacity rate slid to 77.1%, the lowest in over a year. The gain in manufacturing output last month was fairly broad, including increases in machinery, motor vehicles, electrical equipment and appliances as well as computers. Excluding autos, factory production climbed 1%, the most in nearly a year. By market group, output of consumer durable goods, business equipment and construction supplies all increased. Utility output slumped a record 9.9%, while mining increased 2%, the most since March. Oil and gas well drilling fell for a third month.

US homebuilder sentiment increased in February by more than forecast, indicating an easing of mortgage rates over the past several months is helping support the housing market after a year-long rout. The National Association of Home Builders/Wells Fargo gauge rose 7 points, the biggest advance since mid-2020, to 42 this month, figures showed Wednesday. The median estimate in a Bloomberg survey of economists called for a reading of 37. The increase in sentiment to a five-month high was fueled by more optimism about sales, the outlook and a pickup in prospective-buyer traffic. Despite a tough 2022 for real estate, consecutive monthly gains in confidence suggests cautious optimism about demand during the critical spring selling season. “Even as the Federal Reserve continues to tighten monetary policy conditions, forecasts indicate that the housing market has passed peak mortgage rates for this cycle,” Robert Dietz, NAHB chief economist, said in a statement. “While we expect ongoing volatility for mortgage rates and housing costs, the building market should be able to achieve stability in the coming months, followed by a rebound back to trend home construction levels later in 2023 and the beginning of 2024,” he said. The NAHB report showed sales expectations for the next six months jumped 11 points to 48, the highest since July. The group’s measure of current sales rose to a five-month high, while an index of prospective-buyer traffic was the strongest since September.

US producer prices rebounded in January by more than expected, underscoring persistent inflationary pressures that could push the Federal Reserve to pursue further interest-rate increases in the months ahead. The producer price index for final demand jumped 0.7% last month, the most since June and bolstered by higher energy costs, according to data out Thursday from the Bureau of Labor Statistics. The PPI climbed 6% from a year earlier. The median estimates in a Bloomberg survey of economists called for the index to increase 0.4% from a month earlier and 5.4% from January 2022. Excluding the volatile food and energy components, the so-called core PPI advanced 0.5% in January and 5.4% from a year earlier. The data come just days after the closely watched consumer price index showed lingering and still-elevated inflationary pressures despite the Fed’s aggressive monetary policy actions over the past year. The PPI, which is a measure of wholesale prices, has generally been cooling in recent months amid improving supply chains, a pullback in many commodities prices, and a tempering in goods demand. That said, inflation appears to be stickier than many anticipated. Looking ahead, the strength of the labor market as well as global commodities prices will be key for the overall inflation picture. While the overall figure was bolstered by a 1.2% jump in goods prices, also the largest since June, some key services measures rose firmly. Hospital outpatient care increased 1.4% last month, while price indexes for auto retailing, portfolio management and airline services also moved higher. Several categories from the PPI report, notably health care, are used to calculate the personal consumption expenditures price gauge. Those figures will be released next week. Producer prices excluding food, energy, and trade services — which strips out the most volatile components of the index — increased 0.6%, the sharpest advance since March.

U.S. weekly jobless claims fell by 1,000 to 194,000 last week compared to the estimate for 200,000 demonstrating the continued tightness of the labor market. The forecast range was 187,000-210,000 from 44 economists surveyed. The 4-week moving average now is at 189,500 in the week ending Feb. 11 and the prior week’s claims were revised down to 195,000 from 196,000. New US home construction retreated for a fifth month in January as elevated mortgage rates continue to keep a lid on housing demand. Residential starts decreased 4.5% last month to a 1.31 million annualized rate, marking the longest stretch of declines since 2009, according to government data released Thursday. Single-family homebuilding fell to an annualized 841,000 rate. Applications to build, a proxy for future construction, were little changed at an annualized 1.34 million units. Permits for construction of one-family homes declined 1.8%. The median estimate in a Bloomberg survey of economists called for a 1.36 million pace of total residential starts.

Interest Rate Insight and the Fed

Not surprisingly Fed officials were on the road this week with more “Fed Speak” after this week’s inflation report and the message they were touting was the same that we have heard for some time. We will not highlight all of the speakers – we will focus on just one. Federal Reserve Bank of Richmond President Thomas Barkin said the central bank may need to raise interest rates to a higher level than previously anticipated should inflation keep running too fast for comfort. “Inflation is normalizing but it’s coming down slowly,” Barkin said Tuesday in a Bloomberg TV interview with Michael McKee. “We may or may not choose to take rates up further if inflation continues to persist but we’ll have to see what happens,” he said. If inflation settles down, borrowing costs may not need to rise so high, but “if inflation persists at levels well above our target, maybe we’ll have to do more.” Barkin spoke shortly after data showed consumer prices climbed 6.4% in January from a year earlier, still far above the Fed’s goal for 2% annual inflation, which is based on a separate measure. The Fed increased its policy rate by 25 basis points on Feb. 1 to a range of 4.5% to 4.75% and promised ongoing rate hikes to counter high inflation. Traders on Tuesday were pricing in quarter-point increases at the March and May policy meetings, and near-even odds of another one in June. Fed officials will update their forecasts at the next meeting, which takes place March 21-22. Barkin doesn’t have a vote on interest rates this year. He noted that additional inflation reports are due before the March gathering and will weigh on his forecasts. Investors have lifted where they see rates peaking this year and are now broadly in line with policy makers’ projection of 5.1% following stronger-than-expected jobs reports and continued signs of persistently high prices. Policymakers have been particularly worried by increases in services prices, driven in part by a shortage of workers exacerbated by the Covid-19 pandemic.

Fed Chair Jerome Powell has cautioned that an easing in a too-tight labor market would be needed to cool continuing price pressures. Nonfarm payrolls increased 517,000 last month – more than twice the expectations of Wall Street – and the unemployment rate dropped to 3.4%, the lowest since May 1969. “The risks are on the inflation side as opposed to on the economy side,” Barkin said. “The biggest surprise has been the jobs market” with its unexpected strength, he said. The Fed has sought to ease wage gains to a level consistent with its 2% inflation goal. The jobs report showed average hourly earnings rose 0.3% from December and up 4.4% from a year earlier, yet the prior month was revised higher. There are some indications that economic growth could be more resilient than expected, or even accelerating. The Atlanta Fed’s tracker has put an early estimate of first-quarter gross domestic product at 2.2%, as of Feb. 8. “You have seen demand moving very quickly” in some sectors, Barkin said. As we said, the message has been consistent and points to continued rate hikes from the Fed.

Impactful International News

European Central Bank Executive Board member Fabio Panetta said raising borrowing costs in small increments would allow for more honed adjustment as previous tightening starts to put a brake on economic activity. “With rates now moving into restrictive territory, it is the extent and duration of monetary policy restriction that matters,” Panetta said in a speech in London on Thursday. “By smoothing our policy rate hikes – that is, moving in small steps – we can ensure that we calibrate both elements more precisely in the light of the incoming information and our reaction function.” The ECB raised interest rates by 50 basis points this month while saying it intends to take an identical step at the next meeting — a stance that President Christine Lagarde reiterated to European Parliament lawmakers on Wednesday. Subsequent moves are still up for debate, and they’ll be informed by new economic projections that will reflect a recent drop in energy prices. “To move in small steps is not to move less,” Panetta said during questions. “We face so much uncertainty in both directions, I would consider it unwise to move very fast.” As the energy shock caused by Russia’s war in Ukraine eases and risks to the inflation outlook become more balanced, “we now need to take into account the risk of overtightening alongside the risk of doing too little,” he said. The comments come after the ECB raised interest rates by 300 basis points since July, the most aggressive tightening campaign in its history. The full impact of these measures on demand in the euro area “will only be felt in full over the coming quarters,” according to Panetta.

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