Labor demand remains unbent by higher rates: Weekly Economic Review & Outlook

The labor market continues to be incredibly resilient despite the Fed’s efforts to dampen the strong demand for workers. Nonfarm payrolls beat expectations and the unemployment rate fell to a cycle low, while firms continue to list open positions at a rate unprecedented prior to the current cycle. Conversely, the ISM surveys for both manufacturing and services showed contraction in December — the first time both surveys have been simultaneously in contraction in over 13 years outside of the Covid lockdown period — with reduced price pressures across the business sector.

Key Takeaways:

What we learned last week: (pg. 1)

Unemployment rate falls to cycle low

Despite the Fed’s efforts to slow labor demand, the unemployment rate fell back to 3.5 percent in December.

Service sector plummets into contraction

The ISM services index fell sharply and is now in contraction. It is the first non-Covid contractionary reading since 2009.

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

January 10: NFIB survey to underscore growth concerns

The NFIB small business survey provides a variety of readings on key economic activities beyond the headline optimism index, which consensus expects to remain little changed at around 91.5 in December. The share of firms raising their average selling prices is a proxy for broad-based corporate pricing power (beyond small businesses) and tends to be a leading indicator for changes in core inflation. This price metric has been trending lower but remains quite high with slightly over half of the surveyed companies raising prices. How this measure fares has implication for the near-term course of inflation. Further, small companies have reported that inventory levels are too high, echoing the same sentiment captured in the ISM manufacturing and non-manufacturing surveys. As such, companies will pull back on new orders which in turn depresses production activity.

January 12: CPI expected to continue cooling

The CPI report is the key indicator for the week given that inflation determines the course for Fed monetary policy. We look for a 0.1 percent decline in headline CPI and a moderate 0.3 percent advance in core CPI (excludes food and energy) in December. The 12.5 percent drop in gasoline prices on the month helps lower the headline reading, more than offsetting a moderating but still buoyant increase in food prices of around 0.5 percent. On a year-on-year basis, overall CPI should decelerate to 6.4 percent from 7.1 percent in November and the core CPI pace should slow from 6.0 percent to 5.7 percent. These readings would be encouraging for the Fed, however, with the rate of inflation still substantially elevated, policymakers should still be inclined to lift the policy rate above 5.0 percent by May.

January 13: Consumer sentiment likely improves with receding inflation

The University of Michigan consumer sentiment index should continue to improve with the sharp 12.5 percent drop in gasoline prices in December and the moderating advance in overall prices. Keeping with that theme, consumers’ expectations for inflation over the next year should continue to trend lower, extending the decline from the recent peak of 5.4 percent in April to 4.6 percent in December. The key inflation expectations for the next five years remained elevated at 2.9 percent in December — any movement in this measure will be important to watch.