Weekly Economic Commentary

Inflation: From let's party to party pooper!

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Even at the risk of sounding like a parrot by repeating the same thing again and again, we think that it is, once again, appropriate at this time to do so: “One data point doesn’t a trend make.”

But it is clear that markets don’t care about trends, they live in the moment; if they see something they like or don’t like, they just react to it. This is what happened last Friday, when the Bureau of Labor Statistics (BLS) revised the seasonal factors for the Consumer Price Index for the whole of 2023, which showed that December month-on-month inflation was lower than what was originally reported – 0.2% versus an original release of 0.3%. Never mind that the year-over-year rate of inflation did not change at all. That is, even though the rate of inflation for December moved lower – from an originally reported 0.3% to 0.2% – every monthly seasonal factor during the year was revised so, overall, the effect of the revision for the year as a whole was non-existent, which should have been the message received by markets, not just the December revision.

This was not the first time that inflation numbers have pushed markets from euphoria to dismay and/or disappointment, and we should not dismiss more of these episodes coming our way during the next several months. The Federal Reserve (Fed) Chairman, Jerome Powell, clearly indicated that the Fed was not convinced inflation was guaranteed to continue its disinflationary process toward its 2.0% target. Although he said he was not concerned with an acceleration in inflation, he was concerned with the potential for inflation to remain above the Fed’s target. We wrote about this issue in last week’s Weekly Economics, using the Fed’s preferred Personal Consumption Expenditures (PCE) price index, which, by the way, has been reporting a 2%-handle rate of inflation for several months, unlike the Consumer Price Index (CPI).

But we also mentioned that housing prices within the PCE price index measure were also of great concern for the Fed even though housing prices have a much lower weight in the PCE price index compared to the CPI price index – about 15% versus 33%, respectively.

As many, including us, have argued in the past, housing prices' effects on both the CPI as well as the PCE calculation of inflation are different than other goods and services we buy often, such as gasoline, food, electricity, etc. Thus, people don’t feel the effects of housing prices often, and some, especially those who are homeowners and don’t move out of their homes, rarely experience them. Renters plus those that buy a new or existing home are the only ones being affected by higher housing prices. However, they only experience them when they move and/or renew their rent agreement or purchase agreement.

At the same time, housing prices typically affect these indices with very long lags. We had estimated that increases or decreases in home prices would start to seep into inflation indices with a lag of about 12 to 18 months. And we have already seen some slowdown in shelter prices within these indices over the last year or so. However, instead of further weakness lately, we have started to see shelter prices accelerating once again, which is bad news for the Fed and the prospects for achieving the 2% inflation target.

Perhaps one of the reasons for this renewed increase in shelter costs has to do with the fact that home prices started to increase more than six months or so ago for both new homes as well as for existing homes. This could be an issue going forward for the Fed.

Recall that the Fed needs to see monthly inflation increasing by about 0.15% per month on a sustained basis to achieve a 2.0% target, and that has not been the case (see the graph below). Thus, the Fed will remain unconvinced until it sees sustained downward movement in the rate of inflation, both monthly as well as year-over-year.

Updates to Our Forecast

We have updated our GDP forecast for the first quarter of 2024 on account of the strength in economic activity during the first quarter of the year. This update to our first quarter forecast will take economic growth for the whole of 2024 to 1.7% compared to our current, 1.3% estimated growth rate. For now, we are keeping our forecast for a very mild recession during the year as we remain concerned that high interest rates for longer will finally slow down economic activity and could pose a risk to economic growth during the next several quarters.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the U.S. dollar gains "strength" when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 7/7/2023