Trend watch and what’s new this week
Air passenger traffic continues to closely track the 2019 pattern. Right on cue, the weekly air traveler count rebounded during the week of Labor Day, snapping a six-week decline streak from the late July peak.
Yet, most of the other activity-based data has softened (slides 5 and 6). While seasonality is certainly a factor, it doesn’t explain away all of the weakness, especially for freight volumes, which have been soft for months and are well below last year. We’re not jumping to any conclusions that it portends something sinister, but the trends aren’t moving in the right direction.
Mixed signals from the services indices
On slide 7, the Institute for Supply Management (ISM) Services Index had a reading of 54.5 in August, expanding for the eighth month in a row after briefly contracting in December ’22. Meanwhile, the prices paid component rose to 58.9, which was a four-month high. Still, prices have declined 12 times in the past 16 months.
However, the final August reading of S&P Global’s U.S. Services Index slipped to 50.5, weakening for a third month in a row and is barely expanding, as a reading below 50 signifies that activity contracted.
Used car prices edged up in August, but down sharply YoY
On slide 8, we revisit the price index of used vehicles, which rose 0.2% in August. That snapped a streak of four monthly declines. Prices declined 7.7% on a year-over-year basis, which is a far cry from the 54% spike in April ’21. Prices peaked in January ’22 and have rolled back nearly 18%. Compact and mid-size cars continue to see the biggest price declines on a year-over-year basis.
Gasoline prices are climbing again
On slide 9, we show the nationwide average price for gasoline, which has climbed to $3.81 per gallon. It is likely heading higher due to limited global supply thanks to extended production cuts by Saudi Arabia and Russia. U.S. gasoline remains roughly $1 per gallon, or 34%, above the pre-pandemic level of $2.85, challenging consumers and reigniting inflation, which will likely force the Federal Reserve (Fed) to maintain higher interest rates for longer.
Our take
We have repeatedly discussed crosscurrents, even sometimes within the same report. The August services indices were simply more examples as both showed cooling and reacceleration in prices.
The consistent trend had been that goods prices are generally waning, while prices for services are reaccelerating; however, that, too has turned. Now, some goods prices are increasing, including the aforementioned used vehicle prices. Last week, the price component of the ISM Manufacturing Index rebounded to a four-month high.
Then we heap on climbing gasoline prices. This complicates the Fed’s attempts to stabilize prices. The overall cooling trends of economic data may provide another opportunity for the Fed to skip hiking interest rates in September, much as it did in June. But, the stickiness of prices – as well as wages – will likely require further rate hikes to tame inflation.
This is why we are beginning to view a soft landing scenario as self-defeating – the stronger the economy remains ultimately translates into higher interest rates for longer as the Fed battles persistent inflation.
Furthermore, a soft landing scenario undercuts the need for rate cuts, which futures-based market expectations see happening as soon as the March ’24 Fed meeting. At the very least, the Fed will need to maintain rates higher for longer lest inflation reaccelerate.
Alas, this is why we maintain our view that a recession, accompanied by eventual job losses, is likely. It would be unprecedented to avoid a recession with weakening leading indicators, higher interest rates, and tighter financial and credit conditions.
Many of the leading indicators are pointing downward and have been for more than a year. Moreover, most of the incoming economic data has been decelerating, not strengthening. That said, we don’t anticipate a sudden collapse in economic activity and don’t view the economy as overly weak. Regardless, it’s certainly not as strong as many of the soft-landing bulls are projecting.
Additionally, we are concerned about restarting student loan payments for 46 million people in the next month (roughly one million have already voluntarily restarted payments). In our opinion, that’s going to take a LOT of wind out of the economy. And we didn’t even get into the discussion of what parts of the economy will buckle under higher interest rates for an extended period. For example, commercial real estate appears particularly vulnerable.
Lastly a reminder that most recessions initially look like a soft landing with very few exceptions (like 2020). The economic data cools and conditions look fairly stable until they don’t.
Bottom line
A shallow recession remains our base case as dramatically higher interest rates and tighter credit conditions ratchet up 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 and the timing remains fluid.
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