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Weekly Update March 3, 2023: Interest Rates Rise on Sticky Underlying Inflation

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Domestic Economic News

A gauge of manufacturing improved for the first time in six months, though activity remained in contraction territory amid fragile demand and growing inflationary pressures. The Institute for Supply Management’s gauge of factory activity ticked up to 47.7 in February from the weakest print since May 2020. The median estimate in a Bloomberg survey of economists was for 48. Readings less than 50 indicate contraction. The latest data, released Wednesday, highlight a manufacturing sector that’s struggling for a foothold. While household demand rebounded at the start of the year, rising interest rates, higher input costs and looming concerns of an economic downturn remain persistent headwinds. Fourteen industries reported contraction in February, led by the printing, paper and wood products industries. Four sectors expanded. “New order rates remain sluggish due to buyer and supplier disagreements regarding price levels and delivery lead times; the index increase suggests progress in February,” Timothy Fiore, chair of ISM’s Manufacturing Business Survey Committee, said in a statement. “Panelists’ companies continue to attempt to maintain headcount levels through the projected slow first half of the year in preparation for a stronger performance in the second half.” The ISM’s new orders index rose in February by the most since 2020, while the production gauge slipped to 47.3. Even with the improvement, the gauge of bookings remained below 50, indicating orders continued to shrink in the month. Inventories were little changed.

The US merchandise-trade deficit widened for a second-straight month in January as the value of imports advanced more than exports. The shortfall increased 2% to $91.5 billion last month, the widest in three months, Commerce Department data showed Tuesday. The figures, which aren’t adjusted for inflation, compared with a median estimate for a gap of $91 billion in a Bloomberg survey of economists. Exports grew 4.2% to $173.8 billion. Imports rose 3.4%, but more in dollar terms, to $265.3 billion. A rebound in domestic demand at the start of the year helped boost US imports of autos and consumer goods in the month. Autos rose 9%, matching the biggest increase since September 2020. Meantime, a weaker dollar at the start of the year likely supported foreign demand as US goods became comparably cheaper. Exports of consumer goods rose 14.8%, the most since July 2020. Outbound shipments of autos climbed 8.2%, the most since October 2021. The data come on the heels of the government’s second estimate of fourth-quarter gross domestic product, which showed net exports added modestly to growth. Prior to Tuesday’s report, the Atlanta Fed’s GDPNow estimate showed trade adding about 0.8 percentage points to first-quarter growth.

US consumer confidence unexpectedly declined in February, as rising prices and deepening concerns about the outlook outweighed the near-term strength of the labor market. The Conference Board’s index decreased to 102.9 from a 106 reading in January, data out Tuesday showed. The median forecast in a Bloomberg survey of economists called for the gauge to rise to 108.5. A measure of expectations — which reflects consumers’ six-month outlook — decreased to 69.7, the lowest since July, while the group’s gauge of current conditions rose to 152.8. The decline in confidence reflects more pessimistic views on jobs, incomes and business conditions in the next six months. Inflation is proving to be stickier than many anticipated, and the Federal Reserve is expected to raise interest rates higher. Not only are the higher prices eroding Americans’ purchasing power, but aggressive Fed policy risks tipping the economy into recession. That said, layoffs so far have largely been contained to the technology and finance sectors, and the unemployment rate across the economy has fallen back to a 53-year low. The share of consumers who said jobs were “plentiful” surged to 52%, the highest since April. Those who say jobs are hard to get ticked down.

While consumer spending rebounded at the start of the year, forward-looking signs are tentative. Americans scaled back plans to buy major appliances, homes and cars in February, and vacation intentions also declined, the report said. “Consumers may be showing early signs of pulling back spending in the face of high prices and rising interest rates,” said Ataman Ozyildirim, senior director of economics at the Conference Board. Executives can’t seem to find a consensus on how they describe the health of consumers, judging by recent earnings calls. Live Nation Entertainment Inc. Chief Executive Officer Michael Rapino said they continue to see strong consumer demand globally “with no sign of any slowdown.” On the other hand, retailer TJX Cos. Inc. CEO Ernie Herrman pointed to a greater shift toward value, and Molson Coors Beverage Co. stressed the uncertainty of the consumer landscape. The median inflation rate seen over the next 12 months declined in February. Data out last week showed the Fed’s preferred inflation metrics accelerated in another sign of stubborn price pressures.

Applications for US unemployment benefits eased last week, remaining at a historically low level, the latest sign of a tight labor market in which most businesses are reluctant to dismiss workers. Initial unemployment claims decreased by 2,000 to 190,000 in the week ended Feb. 25, Labor Department data showed Thursday. The median forecast was for 195,000 applications. The claims figures can be volatile week-to-week but tend to be even more so around holidays. The latest period included Presidents Day. Continuing claims, or the number of people who have already filed an initial application and are now claiming unemployment benefits, eased to 1.66 million in the week ended Feb. 18. The four-week moving average in initial claims, which smooths out some of the week-to-week volatility, edged up to 193,000. The figures underscore the enduring strength of the labor market. While a number of high-profile firms, predominantly in technology and finance, have announced job cuts in recent months, layoffs across the economy remain historically low. That said, economists and investors are watching the claims data closely for any sign the labor market is starting to crack under the weight of still-rapid inflation, high labor costs and interest-rate hikes by the Federal Reserve. Separate data showed fourth-quarter labor costs increased more than initially reported. The Bureau of Labor Statistics report showed unit labor costs climbed an annualized 3.2% in the period, nearly three times the preliminary estimate. Productivity grew by roughly half as much. On an unadjusted basis, initial claims fell to 201,710 last week, reflecting declines in Kentucky and California. Data out next week, including January job openings and the February employment report, will offer additional insight into the state of the US labor market.

Interest Rate Insight and the Fed

The Institute for Supply Management’s measure of prices paid for materials rose for a second month. At 51.3, it was the first time since September that the figure indicated rising costs. That is a worrisome trend as the Fed continues to battle inflation by raising interest rates. The share of respondents reporting they paid higher prices rose to about 25%, also the highest in five months. The step-up in input prices comes on the heels of data last week that showed the Federal Reserve’s key inflation gauges accelerated at the start of the year. Looking ahead, persistent inflation and a resilient economy are poised to push the Federal Reserve to pursue additional interest-rate hikes in the months ahead. In response, the US dollar has begun strengthening once again. While that lowers the cost of imports, it also weakens demand in international markets for US-produced goods.

US mortgage rates increased last week to the highest since mid-November, pushing down a gauge of home-purchase applications to the lowest level in nearly three decades. The contract rate on a 30-year fixed mortgage rose 9 basis points to 6.71%, the highest since the week ended Nov. 11, according to the Mortgage Bankers Association. The group’s index of mortgage applications to buy a home fell for a third week, still the weakest reading since 1995. Mortgage News Daily, which updates more frequently, put the 30-year rate at 6.85% on Tuesday. The MBA’s index of refinancing applications dropped 5.5%, also the third-straight decline. The gauge of overall mortgage applications fell 5.7% to 188.5 in the week ended Feb. 24, the weakest since the start of the year. The data can be volatile around holidays, and the week included Presidents’ Day. 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.

Federal Reserve Bank of Atlanta President Raphael Bostic said he still prefers to raise rates by another quarter percentage point when officials meet later this month, but is mulling whether central bankers need to lift borrowing costs higher than the range of 5% to 5.25% he’s endorsed to defeat inflation. This actually helped lift sentiment in Thursday trading as many traders have been pricing in the possibility of a 50 bps hike at the Fed’s next meeting. “I let the data guide me,” Bostic told reporters in a press briefing. “If the data continue to come in suggesting the economy is stronger than I had projected, I’ll adjust my policy trajectory.” Bostic, who isn’t a voter on monetary policy in 2023, earlier this week reiterated his call for the Fed’s key policy rate to be lifted to around 5.1% this year and then kept there until well into 2024. The Atlanta Fed chief acknowledged data have come in stronger and said he wasn’t prepared to adjust his formal estimate until going through a comprehensive pre-meeting review with his staff.

Impactful International News

German inflation surprisingly accelerated in February, further complicating the European Central Bank’s task after overshoots this week in other parts of the continent. Consumer prices advanced 9.3% from a year ago, up from January’s 9.2% gain, driven by services and food costs. The move came even as Germany moved to limit household heating bills that rocketed because of Russia’s war in Ukraine. Analysts in a Bloomberg survey had expected a slowdown to 9%. The reading for Europe’s biggest economy puts more pressure on the ECB after French inflation hit a euro-era record and Spanish price growth defied estimates to moderate. That prompted markets for the first time to price a 4% peak in the ECB’s deposit rate, which currently stands at 2.5%. Officials are preparing to raise borrowing costs by another half-point in March, with many backing big moves beyond that until inflation heads sustainably back toward the 2% target. Numbers from the 20-nation euro zone are due on Thursday. Economists predict a slowdown to 8.3% from 8.6%, though the underlying gauge that excludes volatile energy and food costs — the main focus for ECB policymakers of late — is seen remaining at a record 5.3%.

China’s economy is showing signs of a stronger rebound after Covid restrictions were abandoned, with manufacturing posting its biggest improvement in more than a decade, services activity climbing and the housing market stabilizing. The manufacturing purchasing managers’ index rose to 52.6 last month, the National Bureau of Statistics said Wednesday, the highest reading since April 2012. A non-manufacturing gauge measuring activity in both the services and construction sectors improved to 56.3. Both indexes beat economists’ expectations. The PMIs provide the first comprehensive data of the economy’s recovery after Covid restrictions were dropped late last year, infection waves began easing and businesses returned to normal after the Lunar New Year holidays. The figures add to other signs of a rebound in the economy and put policymakers in a good position ahead of next week’s National People’s Congress, where a new growth target will be disclosed. While there were “significant seasonal and event factors” influencing the PMI figures, the “overall trend still points to a solid recovery at the beginning of 2023,” said Zhou Hao, chief economist at Guotai Junan International. “The decent PMI readings provide a positive note for the upcoming National People’s Congress,” with the government expected to roll out further supportive policies to cement the recovery, he said. The improving factory data suggests the recovery is becoming more balanced as well, after the sector was initially lagging because of a slump in exports, weak business confidence and Lunar New Year. Economists continue to caution though that global demand remains weak and exports will likely contract this year.

Other data has signaled a pickup in domestic demand. China’s home sales rose in February from a year earlier, the first such increase since June 2021 as policymakers expanded support for the sector. Road congestion in major cities has increased, subway ridership has returned to pre-pandemic levels and restaurant and mall spending has risen. The initial Covid wave following the ending of pandemic restrictions has now subsided, boosting February’s PMI numbers, according to Zhao Qinghe, a senior statistician at the NBS. Measures to stabilize growth in the country have also started to take effect, Zhao added. A separate, private PMI survey focused on smaller companies also showed improvement in February, rising to 51.6 from January’s 49.2. That increase in the Caixin Manufacturing Purchasing Managers’ Index was driven by pickups in both supply and demand as production gradually returned to normal, Caixin and S&P Global said in a statement Wednesday. China’s economy is recovering faster than top officials had expected with the latest Covid outbreak having passed quickly through the country. This suggests the government may be more restrained in rolling out new stimulus measures this year. The infection wave that followed the abrupt removal of pandemic restrictions ended faster than senior officials had expected, the person said, declining to be identified discussing government matters. The outbreak was expected to last at least through to February or March of this year, but most of the population was already infected by the end of January, the person said, allowing the economy to recover quickly. In another sign of growing comfort with the pace of the recovery, Chinese state media were told to convey at next week’s National People’s Congress — the annual parliamentary gathering — that leaders are satisfied with the economic rebound and the need for stimulus is moderate for now, another person familiar with the plans said. The government is looking to “hold up” the economy rather than give extra support, the person said.

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