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Weekly Update 6/30/2023: Fed's Preferred Measure of Inflation Continues to Cool as US Economy Remains Resilient With Consumer Confidence High

Domestic Economic News

The Federal Reserve’s preferred measures of US inflation cooled in May as consumer spending moderated. The personal consumption expenditures price index rose just 0.1% in May, Commerce Department figures showed Friday. The overall annual rate slowed to 3.8% which is the first time the figure has been below 4.0% since April 2021. This was welcome news in Friday trading as stock rose and Treasury yields moderated. Consumer spending, adjusted for prices, was little changed after a downwardly revised 0.2% gain in April. From February through May, household spending has essentially stalled after an early year surge. Spending on merchandise dropped, while outlays for services increased. Excluding food and energy, the so-called core PCE price index increased 4.6% from May 2022. That’s in line with annual readings back to late 2022 and shows minimal relief from elevated price pressures. Economists consider this to be a better gauge of underlying inflation.

US gross domestic product was revised up notably to a 2% annualized advance in the first quarter, data showed Thursday. The government’s third estimate of GDP for the period reflected upward revisions to exports and consumer spending. Household spending, the engine of the US economy, rose at a 4.2% pace — the strongest in nearly two years — as services outlays were adjusted higher. Meanwhile, key inflation gauges watched closely by the Federal Reserve were revised down slightly. The personal consumption expenditures price index excluding food and energy rose at a 4.9% pace in the first quarter. The government’s other main measure of economic activity, gross domestic income, painted a different picture. While improved from an earlier estimate, GDI fell at a 1.8% pace in the first quarter, marking a second-straight decline. Averaging GDI and GDP, the economy grew just 0.1%. Still the overall GDP figure demonstrates the resiliency of the US economy in the face of aggressive Fed rate hikes.

US consumer sentiment continued to improve through the end of June, while short-term inflation expectations held at a more than two-year low. Again this was all welcome news this week! The University of Michigan’s consumer sentiment index climbed to 64.4 from a preliminary reading of 63.9, according to the final June reading out Friday. That marked a rebound from a May slump. Consumers expect prices will climb at an annual rate of 3.3% over the next year, matching the preliminary reading. They see costs rising 3% over the next five to 10 years, the data showed. “Overall, this striking upswing reflects a recovery in attitudes generated by the early-month resolution of the debt ceiling crisis, along with more positive feelings over softening inflation,” Joanne Hsu, director of the survey, said in a statement. The pickup in sentiment follows weaker-than-expected May consumer spending data. From February through May, household spending essentially stalled after an early-year surge, a Commerce Department report showed earlier. Key inflation metrics also softened. Hsu noted in the report that uncertainty over both short-and long-term inflation expectations have declined “considerably.” Fewer consumers said they expect extremely high or low inflation in the future. The University of Michigan report showed buying conditions for durable goods increased in June to an almost two-year high. However, consumers remained downbeat about their personal finances. The current conditions gauge increased to a four-month high of 69. A measure of expectations rose to 61.5, also the highest since February.

US unemployment benefits applications fell last week by the most since October 2021 in a week that included the Juneteenth holiday. Initial jobless claims decreased by 26,000 to 239,000 in the week ended June 24, according to the Labor Department’s Thursday report. The figure was lower than all estimates in a Bloomberg survey of economists. Continuing claims, which include those who have received unemployment benefits for more than one week, dropped to 1.7 million for the week ended June 17. Despite the drop in claims, demand for workers has been easing slowly as more than a year’s worth of interest-rate hikes from the Federal Reserve work their way through the economy. Chair Jerome Powell said this week the labor market has been cooling in a way the central bank would have hoped, which, if sustained, could limit job losses down the line. The claims data can be choppy from week to week, especially around holidays, and this period included the Juneteenth holiday. The four-week moving average in initial claims, which smooths out some of that volatility, ticked up to 257,500, still the highest since late 2021. The data may also be especially noisy in the coming weeks with the Fourth of July holiday and as automakers close for their annual retooling period. However, the seasonal adjustments to the claims data “struggle with the shifting timing, extent, and duration” of the shutdowns, said Ian Shepherdson, chief economist at Pantheon Macroeconomics. “Our inclination is to think that post-Covid catch-up in production means that shutdowns are likely to be less extensive than usual, so we think a modest net dip in claims over the next few weeks is a reasonable bet, even as the underlying trend continues to rise,” Shepherdson said in a note. On an unadjusted basis, claims decreased to 233,048, led by California, which reversed a large jump from the prior period. Texas also saw a significant drop in applications.

In additional US economic news this week, new durable-goods orders surged in May, but the headline growth masks weaknesses under the surface. For core capital-goods orders, a downward revision to the previous month’s data takes some of the shine off May’s upside surprise. In any case, the softening trend in core orders remains notable when examined over several quarters. We continue to expect higher borrowing costs and tighter bank-lending standards to restrain firms’ ability to expand going forward. Durable goods orders rose 1.7% month on month in May (vs. a revised 1.2% prior), supported by a surge in orders for non-defense aircraft and parts. That helps core holdings Boeing and Raytheon. That trounced consensus expectations for a 0.9% monthly decline, and the Bloomberg estimate of -1.4%. New orders for non-defense capital goods rose 6.7% to $91 billion. Excluding transportation equipment, new orders rose 0.6% (vs. expectations for no growth). However, about half the upside surprise was due to downward revisions to April’s data. In addition, shipments of non-defense capital goods — which feed directly into GDP calculations — posted a far more modest gain of 0.2% month on month, following a downwardly revised 0.4 gain in April. The relationship between spending on business equipment and durable-goods orders has loosened since the pandemic began. That makes us wary of reading too much into the May data. We expect the third estimate of 1Q23 GDP (due June 29) to show weakening corporate profits, setting the stage for the following quarter’s data to show soft investment.

In some positive economic news this week and helping lift equity markets in Tuesday trading, US consumer confidence rose in June to the highest level since early 2022 as views on current and future conditions improved. The Conference Board’s index rose to 109.7 this month from 102.5 in May, data out Tuesday showed, exceeding all estimates in a Bloomberg survey of economists. The group’s gauge of current conditions jumped to 155.3, the highest level in almost two years. A measure of expectations — which reflects consumers’ six-month outlook — rose to 79.3. “Although the expectations Index remained a hair below the threshold signaling recession ahead, a new measure found considerably fewer consumers now expect a recession in the next 12 months compared to May,” said Dana Peterson, the chief economist at the Conference Board. More consumers said jobs were “plentiful” in June. The share of respondents reporting that jobs were hard to get edged lower, to 12.4%, and their expectations for the labor market six months from now improved. About 15.5% said they expect more jobs to be available in the coming months. The difference between the current “plentiful” and “hard-to-get” measures — a metric watched closely by economists as a gauge of labor-market strength — widened to 34.4, erasing much of the previous month’s deterioration. Buying plans for cars, homes and major appliances slowed, which the Conference Board said may reflect higher borrowing costs. The share of consumers who reported intentions to take a vacation in the next six months fell. The median inflation rate seen over the next 12 months eased to the lowest level since December 2020, according to the Conference Board.

Home prices in the US rose for a third straight month, pushed up by growing buyer demand for a tight supply of listings. A national gauge of prices increased 0.5% in April from March, according to seasonally adjusted data from S&P CoreLogic Case-Shiller. The US is in what’s traditionally its busiest homebuying season, with only about half the properties that were listed for sale in spring 2019. The inventory shortage is keeping a lid on transactions, but shoppers determined to seal a deal are often forced to pay more than the asking price in many areas of the country. “The ongoing recovery in home prices is broadly based,” Craig Lazzara, managing director at S&P Dow Jones Indices, said in a statement Tuesday. On a year-over-year basis, prices slipped 0.2%, compared with a 0.7% increase in March. Miami, Chicago and Atlanta reported the highest annual gains among the 20 largest cities. The housing market is still adjusting to mortgage rates that have about doubled from early 2022, cutting into affordability for would-be buyers and discouraging current homeowners from moving. Continued improvement “will depend on the how well the market navigates the challenges posed by current mortgage rates and the continuing possibility of economic weakness,” Lazzara said. In separate housing news, US new-home sales advanced in May to the fastest pace in over a year, bolstered by limited inventory in the resale market. Purchases of new single-family homes increased 12.2% to an annualized 763,000 pace last month, government data showed Tuesday. The median estimate in a Bloomberg survey of economists called for 675,000.

Interest Rate Insight and the Fed

A measure of US core services prices that Federal Reserve officials are watching closely posted its smallest advance since July of last year. Prices of services excluding energy services and housing costs rose 0.23% in May, according to Bloomberg calculations based on data published Friday by the Bureau of Economic Analysis. On a year-over-year basis, they were up 4.53%. Fed Chair Jerome Powell and his colleagues at the US central bank have zeroed in on this part of the consumer-price basket, arguing that sticky prices for such services are likely to keep inflation elevated unless the job market softens. “The place where we haven’t really seen much progress is in non-housing services,” Powell said Wednesday at a European Central Bank event in Sintra, Portugal. “That’s where we’re not seeing a lot of progress yet, and the reason is — one explanation for it is — that labor costs are really the biggest factor by far in most parts of that sector. We need to see a better alignment of supply and demand in the labor market, and see more softening in labor-market conditions, so that inflationary pressures in that sector can also begin to subside,” Powell said. We are making slow and steady progress on this front.

Impactful International News

Germany’s business outlook deteriorated to the lowest seen this year, evidence that Europe’s biggest economy is struggling to cement a recovery after a recent recession. An expectations gauge by the Munich-based Ifo institute fell to 83.6 in June from 88.3 in the previous month. The outcome was much worse than anticipated by any economist in a Bloomberg survey. A measure of current conditions also fell. “Above all, the weakness in the manufacturing sector is steering the German economy into turbulent waters,” Ifo President Clemens Fuest said in a statement. The report underscores how industrial doldrums around the advanced world amid weakening demand from China are weighing on Germany’s factory base, the motor of growth in the wider euro area. A separate assessment in Italy also suggested waning momentum. Output has yet to see a “noticeable pickup,” Germany’s Economy Ministry said this month after a slump that dragged the rest of the region into a recession too. The Bundesbank predicts an overall contraction of 0.3% for this year. Confirming that picture, a survey of purchasing managers published Friday showed that German economic activity lost much more momentum than anticipated in June, driven by a slowdown in services and sustained weakness at the country’s factories. A separate report released on Monday pointed to glimmers of hope. The Bundesbank said the economy probably returned to growth and expanded “slightly” in the three months through June. Hopefully global central bank heads are paying attention to this data and incorporating it into their future decision-making.

In positive news from our friendly neighbors to the North, core measures of Canadian inflation edged lower, reducing some pressure for a July rate hike, as the headline rate slowed to the weakest pace in two years. The consumer price index rose 3.4% in May from a year ago, the smallest increase since June 2021, Statistics Canada reported Tuesday in Ottawa. That matched a median estimate in a Bloomberg survey of economists and was down a full percentage point from 4.4% in April. On a monthly basis, the index rose 0.4%, which also matched expectations. Two key yearly measures tracked closely by the Bank of Canada — the so-called trim and median core rates — also dropped sharply, averaging 3.85% from an upwardly revised 4.25% a month earlier, slightly slower than 3.95% expected by economists. Service inflation — another closely watched measure — slowed to 4.6% in May, from 4.8% a month earlier. A three-month moving average of the measures that policymakers have flagged as key to their thinking fell to an annualized pace of 3.72%, from 3.83% previously, according to Bloomberg calculations. The deceleration of both headline and core inflation will likely give Governor Tiff Macklem and his officials some room to hold interest rates steady at their next decision on July 12, if output and jobs figures show signs of a slowing economy. A string of hotter-than-expected data since the central bank declared a pause in January forced them to hike rates earlier this month to 4.75%, the highest since 2001. We will take any welcome news from any country with respect to receding inflationary pressures!

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