Things Are Looking Up
The economy appears to be in a transition phase. Economic data has been coming in stronger than expected (chart 1), while inflationary pressures are subsiding (chart 2).
CHART 1: Citi Economic Surprise Index
measures economic data surprises relative to market expectations
Source: Citibank Global Markets, as of July 21, 2023.
Information is subject to change and is not a guarantee of future results.
CHART 2: Consumer Price Index
% change, y-o-y, seasonally adjusted
Source: Bureau of Labor Statistics, June 2023.
Information is subject to change and is not a guarantee of future results.
This has some economists pushing out their anticipated recession start, while others are beginning to think the economy may avoid a recession with just a “soft landing.”
The more robust economic data is coming from two unlikely sources. Since the Federal Reserve (Fed) started tightening monetary policy in early 2022, the manufacturing and housing sectors have borne the brunt of the higher interest rates. But in recent months, they appear to have stabilized and reaccelerated. The economy is also benefiting from continued strength in personal spending.
But there is no denying that the big surprise has been the declining trend in inflation. In the past 12 months, the consumer price index (CPI) has moved to just 3% year over year (y-o-y) from a cycle high of 9.1% y-o-y. The initial catalysts for the drop in inflation were the energy and medical sectors, which have continued to fall. Neither of those sectors is influenced by Fed policy. Furthermore, these prices can move down just as quickly as they can move back up. This has given the Fed some uncertainty about the sustainability of the lower level of inflation. The Fed has been more focused on lowering inflation in other sectors of the economy in which it can influence demand and the price movement tends to be more “sticky.” This is where the news has become far more favorable as of late. Service prices, which have been the major contributor to higher inflation in the past couple of years, are beginning to turn (chart 3).
CHART 3: Core CPI – Goods and Services
% change, y-o-y, seasonally adjusted
Source: Bureau of Labor Statistics, as of June 2023.
Information is subject to change and is not a guarantee of future results.
The major portion of service costs is shelter (housing) costs, which have been moving down recently. The three-month annualized change has fallen to 5.5%, a significant decline from the cycle high of February’s 9.5% (chart 4).
CHART 4: Super-Core Inflation
% change y-o-y, not seasonally adjusted
Source: Bureau of Labor Statistics, as of June 2023.
Information is subject to change and is not a guarantee of future results.
Also, the Fed’s “super-core” inflation metric, which measures service costs without housing and tends to be the cost of high labor-intensive services that reflect the cost of labor, is also declining.
Some are crediting the Fed with pulling off “immaculate disinflation,” through which the Fed has been able to reverse the direction of inflation, which was at the highest level in four decades, without a massive increase in the unemployment rate.
Market Trends
US stocks have continued their march higher in July, adding to 2023’s impressive gain that now has the S&P 500 within 6% of the all-time high. However, stretched valuations and optimistic sentiment about economic growth and the path of interest rates leave markets at risk for a correction or pullback. We expect a less supportive environment in the coming months as the Fed maintains its hawkish tilt, recessionary pressures build and earnings estimates are revised lower.
Sources
1. 1. Bureau of Labor Statistics, June 2023
2. The Federal Reserve, July 2023
3. US Census Bureau, Freddie Mac, June 2023
4. Bureau of Economic Analysis, May 2023
5. Bureau of Labor Statistics, June 2023
6. Ward’s Automotive Group, Bankrate.com, June 2023
Index Definitions
The Consumer Price Index (CPI) measures the monthly change in prices paid by U.S. consumers.
The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the US.
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