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Weaker consumer demand helping to cool inflation: Weekly Economic Review & Outlook

April 17, 2023
Illustration of a shopper and a cashier.

March’s cooler CPI data provided further evidence that price pressures are fading in many pockets of the economy. But inflation for services remained high which should keep the Fed on track for another rate hike in early May.

Retail sales dropped in March for the fourth time in the past five months. Households are clearly feeling the pinch from rising interest rates and the extended period of high inflation and are reducing expenses to compensate.

Key Takeaways:

What we learned last week: (pg. 1)

Consumer inflation slows sharply in March

While still much higher than normal, CPI inflation has cooled from last year’s 9.1 percent peak.

Consumers cut spending further in March

Aside from the surge in January, retail spending has been sluggish since November as households look to reduce expenses.

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

April 18: Housing starts

Multifamily starts should tug on March housing starts

Housing starts and building permits, a leading indicator for housing starts, should decline sharply in March. Construction costs continue to be elevated, leading builders to increase prices for new builds – further raising costs for prospective buyers in addition to high mortgage rates. Builders will likely wade cautiously while financing options are still expensive. Multifamily builds, which tend to be volatile, are expected to fall back in March after the surge in February as builders likely got a jumpstart on apartment construction for the coming year.

April 20: Existing home sales

Existing home sales tied to mortgage rate movements

Mortgage rates, which shot up in late February and early March, had fallen back to around 6.3 percent by the end of March. Many potential homebuyers are waiting until financing becomes more reasonable to buy, especially with home prices up so much over the pandemic. As existing homes sales for March mainly represent contracts signed during February, we expect a modest decline to an annualized pace of 4.5 million. But mortgage applications for purchase did rebound over March as demand remains highly sensitive to rates, which could present some upside in coming months.

April 20: Index of Leading Economic Indicators (LEI)

LEI points to elevated recession risk

The index of leading economic indicators (LEI) is expected to retreat again in March, marking the twelfth straight month of decline. New orders for businesses continue to contract while credit conditions have tightened further in response to the banking crisis — likely acting to reduce the LEI this month. March’s expected decrease would push the 12-month change in the LEI further negative, historically an excellent signal of a forthcoming recession. This aligns with other leading indicators, like the yield curve, in predicting a downturn later this year.

Analysis: Services inflation stays elevated

The consumer price index rose by only 0.1 percent in March, slowing the 12-month inflation rate to 5.0 percent from 6.0 percent in February. Lower food and energy costs led the downward trend in March, a much-needed reprieve for household spending at grocery stores and at the pump. The drop in prices for food at home was the first decline since September 2020.

But high services costs continued to push up the core CPI, which rose by 0.4 percent in March to increase the year-on-year rate to 5.6 percent. Sharp increases for transportation services (including car insurance premiums and airline fares) offset declines in used cars prices and medical care services. Housing costs climbed a further 0.6 percent and are now up more than 8.0 percent over the past year. Core services inflation less housing (so called supercore inflation) did decline to 5.7 percent in March, but this was not much lower than its recent peak and far higher than the pre-Covid average of 2.2 percent.

With services inflation showing no sign of abating, the Fed is likely to pursue another rate hike in early May. But this could be the end of the Fed’s tightening cycle as officials assess the cumulative impact of higher interest rates and building signs of stress across the economy. Producer prices declined by 0.5 percent in March, a positive signal that disinflationary trends are gathering steam and reinforcing that the Fed’s restrictive actions are working.

Analysis: Poor spending to round out the first quarter

Retail sales contracted by 1.0 percent in March, much weaker than expectations. There was a broad slowdown in spending over the month, but consumers cut back particularly on goods expenditures — with sharp declines at clothing, appliance, and department stores. This fits with other data which show that higher interest rates and rapid inflation are forcing households to think twice about purchases. The lone area of brightness for retailers in March was online spending, which rose a further 1.9 percent, reflective of the market’s continued shift to internet shopping.

The sluggish March for retail activity and weaker signals from businesses saps much of the momentum heading into the second quarter. Based upon the boom in spending for January, we still expect solid real GDP growth for the first quarter, at around a 1.5-2.0 percent annualized pace, but economic activity is clearly downshifting. The still buoyant labor market should help to hold off a recession in the near term, but we expect recessionary conditions to predominate by the third quarter. The cracks in the consumer sector are widening and a negative turn in hiring activity could be the final blow to place the economy in a recession.


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