Trend watch and what’s new this week
The usual 4th of July holiday impact is rippling through the activity-based data (slides 5 and 6). Most are tracking with historical patterns. However, we are closely monitoring the freight data. Several initial reports for June – volumes at the ports of Los Angeles and Long Beach, Cass Freight Index – show weak freight trends, though June is traditionally a weaker month (May and September are historically the big months). Rail traffic rose 2.2% in June, but has also dropped in recent weeks, though the softness was more than likely the proximity of two recent holidays (Juneteenth and July 4th).
Consumer inflation cooling but core prices still elevated
On slide 7, the Consumer Price Index (CPI) rose 0.2% in June and that was despite a 1.0% increase in gasoline prices. The year-over-year pace of CPI cooled to 3.0%, which was the twelfth consecutive decline.
On slide 8, core CPI, which excludes food & energy, also rose 0.2% month over month. Prices for services rose 0.3%, holding fairly steady for the past five months. The year-over-year pace of core CPI ebbed to 4.8%, down from the peak of 6.6% in September ’22. Among the biggest decliners were used vehicles, which have dropped 5.2% from a year ago. Shelter has cooled but remains above the pre-pandemic pace.
Wholesale prices have collapsed in ’23
On slide 9, wholesale prices, as measured by the Producer Price Index (PPI), rose 0.1% in June. The year-over-year pace cooled to 0.1%, dramatically lower than 11.7% in March ’22. Core PPI, which excludes food & energy, also rose 0.1% month over month, while the annual change continued to slide, up 2.4% from a year ago.
Private rental data shows prices plateaued
On slide 10, we show rents from private rental sources for new leases. Rents spiked during 2021, including a jump of 2.0% during July ’21. That continued in 2022, growing 0.9% per month on average through September ’22, but rents have cooled considerably since then. Rental prices in June rose 0.6% month over month, which is roughly in-line with the pre-pandemic 5-year average of 0.4%. This has positive implications for inflation to continue cooling since there’s a lag between private rental data and CPI.
Consumer confidence jumped, but inflation expectations up, too
On slide 11, The University of Michigan Monthly Consumer Sentiment Survey jumped to a reading of 72.6 in July, the highest since September ’21. However, longer-term (5–10-year) expectations rose to 3.1%, matching the highest level since 2011. One-year inflation expectations also ticked upward to 3.4%, likely reflecting the recent uptick in gasoline prices.
The good news is that consumer and wholesale inflation continued to cool in June. Based on private data, such as the Zillow Rent Index (slide 10) and the Manheim Used Vehicle Value Index, which tracks used auto auctions, we anticipate that the cooling trend will persist.
The bad news is that the downtrend in prices has largely been for goods rather than for services. The largest portion of consumer purchases are for services, roughly 65% versus 35% spent on goods, and labor is a much larger input cost. This is why the Federal Reserve (Fed) remains concerned about the labor market and, more specifically, wages.
As we mentioned here last week, wages are still growing at nearly double the pre-pandemic 10-year average. And job growth, while cooler than the very strong pace of the past few years, isn’t slow. The six-month average is 278,200 – literally 100,000 above the pre-pandemic 3-year average of 177,000. The unemployment rate is hovering near a 50-year low.
Wages will keep upward pressure on prices for services, which is everything from restaurants and medical care to auto repairs and travel. Services (within CPI) rose 0.3% in June, holding fairly steady for the past five months, and is up 5.7% from a year ago. It’s rising faster than overall CPI both on a monthly and year over year basis.
While inflation is clearly cooler than the blistering pace of ’21 and ’22, it remains well above anyone’s comfort level. Ultimately, the broader inflation situation – including wages and labor trends – will force the Fed to keep their foot on the gas. Accordingly, we believe the Fed will hike rates by a quarter point (0.25%) on July 26th.
Lastly, we want to acknowledge that resilience in the economy has increased the probability that the U.S. could skirt a recession – a so-called soft landing. At the beginning of this year, we said a soft landing had less than a 10% chance. Now, that chance is essentially 40% - dramatically higher but still not our base case. Looking ahead, our chief concern is that restarting student loan payments later this year will be a major headwind for consumers on top of the stepdown in growth that has already occurred in 2023. Thus, a mild recession remains our base case.
A mild recession remains our base case as dramatically higher interest rates and tighter credit conditions place additional stress on consumers and businesses going forward. This now includes restarting student loan payments later this year as a result of the recent federal debt deal. We also believe that the Fed will keep interest rates higher for longer. Yet, a recession isn’t inevitable.
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