Economic Data Tracker –
Inflation cooled in December 

Trend watch and what’s new this week

Much of the activity-based data (slides 5 and 6) is still being skewed by the holidays. For instance, dining reservations pulled back sharply after spiking to their highest levels since the pandemic in the prior week.

Hotel occupancy and air passenger counts also slumped WoW, as did staffing levels. However, rail freight carloads surged 13.9% for the first week of ’23 after dropping for the final three weeks of December. We attribute most of these big WoW swings to the holidays.

Inflation continued cooling in December

On slide 7, we show the Consumer Price Index (CPI), which fell 0.1% in December, the first decline since the pandemic. It was driven by gasoline, which dropped 9.4% MoM. The year-over-year pace for CPI slipped to 6.5% from 9.1% in June and the sixth straight decline.

On slide 8, core CPI, which excludes food & energy, rose 0.3% month over month and up 5.7% from a year ago. Among the biggest decliners were used vehicles, which dropped for the sixth straight month, along with tech gadgets. However, services prices rose by 0.6%, propelled by shelter (rents).

On slide 9, we show some possible inflation scenarios. While there are a wide range of potential outcomes, we expect CPI to trend toward 3% to 4% by year-end 2023. That would be considerably lower than the peak this past June, but above pre-pandemic levels. Of course, a recession would accelerate the cooling of prices.

On slide 10, rental price growth—from a different data source—has continued to moderate since spiking during 2021. It rose 0.12% in December, which is less than third of the average monthly increase since 2015 of 0.4%.

Used car prices down sharply year over year

On slide 11, we revisit the price index of used vehicles, which rose just twice during 2022. In December, prices rose 0.8% MoM but have dropped 15% since January ’22. Sports utilities and crossovers appear to be getting hit the worst, closely followed by luxury and midsized cars. Note these private figures are for a full month of sales, while the used vehicle component within CPI are for a partial month.

Our take

Regardless of stocks climb out of the starting blocks for 2023, the U.S. economy is in a precarious spot. While investors are seemingly cheering about the recent December cooler inflation report and cooling wage pressures, we are more circumspect.

Indeed, these cooler inflation readings open the door for the Federal Reserve (Fed) to stepdown the size of rate hikes to 0.25% in February from 0.50% at the December meeting and 0.75% at the prior four straight meetings.

Yet, the receding inflation readings reflect a slowdown in the broader economy. Moreover, inflation remains elevated. Aside from a handful of things like gasoline, prices generally aren’t falling, they’re cooling. Thus, the Fed can’t simply “declare victory” over inflation and stop hiking rates. While we’d acknowledge that the Fed is closer to their end point, if anything, the recent inflation readings reinforce the notion that the Fed will need to soldier on in its battle against inflation.

As we noted here last week, chances have increased for a soft landing, which is a euphemism for sidestepping a recession or a mild slowdown. This is especially true given other receding inflationary pressures from a wide range of indicators from commodities and energy prices to wholesale prices and housing.

However, engineering a soft landing is much harder in practice than in theory. The U.S. economy is huge and complex, more akin to an aircraft carrier than a small pleasure boat. In fact, most people underappreciate the large role momentum plays in the economy, especially considering that many businesses have long lead times depending on the industry.

For instance, building more vehicles means mining more iron ore, forming more steel, stamping more pieces, etc., let alone accounting for shipping times between each step. Each of those steps tend to be performed by third parties and are typically done in different locations.

Accordingly, if companies within those supply chains anticipate less demand, it takes a while to ramp up production. And given the amount of uncertainty, no one would blame companies for being cautious. Therefore, slowing demand is bigger concern for us than “cheering” that inflation is cooling. 

To clarify, while the chances of soft landing have increased, a recession in the coming 12 months remains our base case.

Bottom line

Crosscurrents continue to cloud the view of the U.S. economy. And while we expect the Fed to taper the size and perhaps the pace of interest rate hikes needed to slow the economy, there are more rate hikes coming. A recession in the coming 12 months remains highly probable in our view, though it isn’t necessarily inevitable.

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