Economic Commentary

Banking crisis overshadowed the data, but inflation remains persistently elevated: Weekly Economic Review & Outlook

March 22, 2023
An illustration of a chart going up.

The failures of Silicon Valley Bank and Signature Bank and concerns about the solvency of other U.S. regional banks dominated the attention of investors, business leaders, and consumers last week. The stresses in the banking system and ripple effects in the financial markets even overshadowed the incoming inflation data. However, inflation is not slowing as quickly as the Fed would like, leaving policymakers with a complicated decision this week on whether to hold rates steady given the emergent bank stresses, or continue to increase the fed funds rate by 25 basis points at the policy meeting on Wednesday.

It is now clear that inflation is not the sole focus of the Fed, as it now needs to take into consideration financial stability and lending conditions – the latter which are likely becoming much tighter. Whether the Fed raises rate or holds steady on Wednesday, we see the unfortunate banking developments and ensuing tightening of lending standards as reinforcing our view that the economy is headed for a moderate recession in the second half of the 2023.

Key Takeaways:

What we learned last week: (pg. 1)

Core inflation trends up

Monthly growth in core inflation, led by services, has trended up recently and posted a five-month high in February.

Retail sales decline in wake of January’s spending spree

January’s explosion in retail sales appears to be an outlier, but the level of sales is still high.

What we’re watching this week: (pg. 2)

March 22: FOMC Rate Decision

Will the FOMC stand pat or continue raising rates?

Debate remains centered on whether the FOMC will hold rates steady or continue to increase the policy rate by 25 basis points at the conclusion of its two-day policy meeting on March 22. It is now clear that inflation is not the sole focus of the Fed, as their decision now must take into consideration financial stability and lending conditions – the latter which are likely becoming much tighter. Fed officials argue that they can separate changes in interest rates from banking/market/liquidity stresses due to the use of emergency Fed programs. However, if further stresses emerge in the banking or financial markets, it is reasonable to presume the Fed may skip raising rates on March 22. This does not preclude the Fed from resuming its rate hikes starting in May, but it will depend on several factors. They could execute the opposite of the ECB’s dovish rate hike by delivering a hawkish no rate change. Notably, Europe is experiencing higher inflation and the ECB was further behind the curve than the Fed. That said, the ECB’s action signals central banks’ willingness to keep raising rates to tame global inflation.

March 21 & 23: Existing Home Sales & New Home Sales

Existing home sales rise while new home sales dip

Pending home sales, which spiked 8.1 percent in January, are often looked to as a leading indicator of existing-home purchases given properties typically go under contract a month or two before they’re sold. As such we expect that existing home sales will jump five percent in February to a 4.2 million annual rate. The decline in mortgage rates in January likely accounts for the boost in sales. New home sales on the other hand should pull back around 2.2 percent in February after strong back-to-back monthly gains of 7.2 percent in January and December. Overall, the housing sector will continue to feel the negative weight of high mortgage rates and now further tightening in lending standards due to the ongoing banking stress.

March 24: Durable Goods Orders

Durable goods orders flat, dragged down by another large drop in aircraft orders

New durable goods orders were likely flat overall in February, following a steep 4.5 percent drop in January. Like January, we look for another sizeable drop in aircraft orders to weigh on the headline reading. In February, Boeing, received just five new orders, according to the company website, which is the lowest monthly net order total since January 2021. Excluding aircraft, we look for orders to rise a solid 2.5 percent, after a softer 0.8 percent increase in January. However, adjusting for inflation, real orders even ex-aircraft will be soft, indicative businesses holding their spending reins very tightly.

Analysis: Core consumer inflation is still too high, consumer spending cools

Headline consumer inflation slowed in February, but core inflation remained stubbornly elevated due to the continued strong price growth for services — especially for housing. Annual CPI inflation cooled from 6.4 percent to 6.0 percent in February, while the core rate slowed by only 0.1 percentage point for a second consecutive month to 5.5 percent. While moving downward, the pace of improvement has slowed, and the details of this report were highly mixed.

The core CPI climbed by a five-month high of 0.5 percent, led by services. Housing prices continued to soar, but core services less housing is also remaining very sticky, as the annual pace in the “super core” measure was little changed at 6.1 percent in February. This underscores Chairman Powell’s assessment that the “super core” services category has shown little signs of disinflation. The decline in overall inflation has been led by the sharp slowing in core goods inflation — down to a 12-month growth rate of only 1.0 percent — as supply side improvements continue to ease prices for autos, apparel, and other commodities.

The February retail sales report showed that consumers pulled back on spending, but the level of sales was still strong and continues to drive economic growth. Retail sales declined 0.4 percent in February — the third decline in four months. This suggests that January’s spending spree was likely an aberration rather than a trend reversal. However, given January’s surge, the level of sales is still higher than it was in October, and the resiliency of consumer spending through February is still stronger than previously expected. This should drive economic growth at around an annualized 2.5-3.0 percent pace over the first quarter.

This consumer-driven growth early in 2023 does not change our outlook of a moderate recession starting in the second half of this year. Consumer sentiment dropped to a three-month low in the first half of March due to lower readings for both current economic conditions and expectations for the coming months. It’s possible this could be a leading indicator of further pullbacks in spending — particularly once more substantial slack is created in the labor market.

Expected tightening in lending standards for businesses and households due to the banking stresses introduces further downside risk for consumer activity. Moreover, year-over-year growth in the index of leading economic indicators fell to -6.5 percent in February as signs of building weakness spread across key sectors of the economy


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