Economic Outlook – 11 February 2024

The ISM Services index was in the spotlight. In short, the service sector started the year off on a high note. In January, the headline index jumped to a reading of 53.4, up from 50.5 in December. The surprisingly strong upturn is evidence that service sector activity is still running at a fairly solid pace, despite markedly higher interest rates intended to cool inflation by slowing down overall economic growth. The overall resilience in services largely looks owed to consumers and businesses gradually returning to pre-pandemic spending behaviours, such as going on vacation and attending concerts or business conferences. Most of the ISM’s major underlying components improved during January. The new orders component posted a solid gain, while the employment component rebounded strongly and rose 6.7 points to 50.5 during the month, just above the 50-line designating expansion. On balance, hiring in the service sector has been hovering around break-even for some time, which is consistent with the loss in job growth breadth exhibited in recent months in the nonfarm payroll report. Nevertheless, the upturn in ISM employment suggests a broader swath of service firms increased hiring to start the year   The remarkably resilient pace of economic growth recently largely can be chalked up to an unflagging pace of consumer spending. The surprising strength of the consumer begs the question: To what extent are households using credit to fuel their spending habits? In December, consumer borrowing increased to a record $5.01 trillion. However, the absolute change in outstanding credit amounted to $1.6 billion, well below the Bloomberg consensus and the smallest gain in four months. For context, total consumer borrowing surged by $23.5 billion in November as the holiday shopping season got under way. December’s smaller-than-expected gain occurred as revolving credit, which is mostly credit cards, rose $1.0 billion, and non-revolving credit increased nearly $520 million. Through the monthly volatility, consumer borrowing has downshifted as interest rates have moved higher. In 2023 as a whole, consumer credit increased 2.4%, down from a 7.6% gain in 2022. Revolving and non-revolving credit rose 8.4% and 0.4%, respectively   Total mortgage applications rose 3.7% in the week ending February 2. Mortgage applications are highly volatile on a weekly basis, yet an improving trend has been evident for the past several months. Since October 2023, refinancing applications have risen 46%, while purchase applications are up 23%. The increase coincides with the 30-year mortgage rate falling from 7.8% last October to an average of 6.6% so far in 2024. Should mortgage rates continue to gradually decline, then housing activity will likely continue to climb higher and be supportive of economic growth in the year ahead   The trade deficit widened in December, moving from $61.9 billion to 62.2 billion. This was mainly due to $3.8 billion increase in goods imports (to $260.3 billion) led by pharmaceutical preparations, cell phones, and industrial supplies and materials. On a country-by-country basis, the US goods deficit widened with China, Vietnam, and Germany. The service surplus, meanwhile rose from $26.5 billion to a post -pandemic high of $26.8 billion in December. Travel exports continues to recover but remained below pre-pandemic level. Inversely, travel imports, (a proxy for the number of Americans travelling abroad), stood roughly 20% above the pre-pandemic level   With very little in the way of primary data releases, speeches from several Fed presidents and other Fed officials took center stage this week. Overall, the messaging was similar: the Fed needs to see further improvement on inflation, and with the economy on solid footing it can afford to be patient about the timing of rate cuts. Their remarks largely echoed those made by Fed Chair Powell on Sunday. Besides reiterating his message that the Fed is wary of cutting rates too soon, Powell covered a lot of ground in the ‘60 Minutes’ interview. Two comments a bit peripheral to monetary policy stood out. The first was on commercial real estate (CRE), where Powell characterized the risks as  a ‘manageable’ problem for larger banks, and alluded to the low probability of a repeat of the events that unfolded during the Global Financial Crisis. However, he did note that some smaller banks that have large exposures to CRE may ‘close or be merged out’. The other comment from Powell that stood out was his assertion that the U.S. is on an “unsustainable” fiscal path, with debt growing faster than the economy in the long run. To this end, the Congressional Budget Office (CBO) released new 10-year projections this week, which showed that the ratio of federal publicly held debt to GDP will rise from 97.3% last year to record high of 116% by 2034   The US Congressional Budget office projects that if the laws presently on the books remain unchanged, the nation’s debt/GDP ratio will rise to 116% in 2034 from 99% in 2024. Annual deficits are forecast to rise from $1.6 to $2.6 trillion over the coming decade due to higher spending on interest and social services. The CBO projects a 5.6%-of-GDP federal budget deficit for 2024   Testifying on Capitol Hill, US Secretary of the Treasury Janet Yellen said that she has concerns about commercial real estate but that regulators are working to ensure loan loss reserves and liquidity levels are adequate to cope with the stress. Richmond Federal Reserve Bank President Thomas Barkin said Thursday that the commercial real estate problems of regional banks won’t be enough to get the Fed to cut rates early   Total household debt in the United States grew about 1% in the fourth quarter of 2023, to a record $17.5 trillion, the New York Fed reported Tuesday. Fed researchers found that “with the pandemic policy supports in the rearview mirror, delinquency rates for most credit types have been rising after having reached very low levels during 2021. The increasing transition rates merit monitoring in the months ahead, particularly with the amplified distress shown by borrowers in lower-income areas.“   Most of the major indexes moved higher over the week, with the S&P 500 Index reaching new highs and breaching the 5,000 threshold for the first time. The advance remained relatively narrow, however, with an equally weighted version of the index significantly trailing the standard market-weighted version for the fourth time in five weeks. A downward trend in the number of stocks that remained above their 50-day moving average is visible. The narrowness may have reflected in part a relative dearth of economic data, leaving investors to focus more on individual companies’ earnings reports   In terms of data release, Cpi is out on Tuesday. The inflationary environment has improved markedly over the past year. Consider the core CPI (prices excluding food and energy) entered last year growing at an annual rate of 5.7% and finished 2023 up ‘just’ 3.9%. Yet even considering this progress, core inflation is still running at and uncomfortably fast pace for the Fed. Falling gasoline prices and moderating price increases at the grocery store should keep the headline gain in check   Consumer spending has remained remarkably resilient over the past year. Even as households have normalized spending habits by dedicating more of their wallet share back toward services, goods consumption has continued. Retail sales for instance were up 5.6% in December compared to a year earlier, hardly an indication of a large pullback in goods demand. Demand was also broad-based in December with sales activity ending the year with a bang. Households have benefited from a real income tailwind over the past year as inflation is slowing faster than wage growth. Income was likely again supportive of spending in January as average hourly earnings leaped 0.6% during the month. Preliminary data on credit card spending from the BEA suggests an uptick in January spending.

The pound held steady against the dollar on Friday but closed in on a seventh straight week of gains versus the euro as investors grow more convinced by the Bank of England’s determination to keep interest rates where they are for now. BoE policymaker Jonathan Haskel, who voted to raise interest rates last week, said he is encouraged by signs that Britain’s inflation pressures might be on the wane but he would need more evidence of a cool-down before changing his stance. I’m not going to apologise for banging on about persistence because I think we’re right to,” Haskel told Reuters. Next week brings a raft of key UK data, including consumer inflation and economic growth, all of which have the power to influence the rate outlook. Sterling was last down 0.1% against the dollar at $1.261 and narrowly in positive territory against the euro at 85.38 pence. The pound is on track for a modest gain this week, bringing its rally against the euro to seven consecutive weeks, the longest such stretch since mid-2021. “The sterling market definitely has its own thing going on right now and next week is going to be absolutely critical,” Kathleen Brooks, research director for broker XTB, said. “The Bank of England, with its cries for time last week, wants to see more evidence. That means that the inflation report and the labour market report as well, are two things that are going to generate a huge amount of volatility and I think that will play out a lot in sterling,” she said   Britain’s labour market cooled in January as pay growth in new permanent jobs eased to the lowest level in almost three years, according to a survey that might boost Bank of England officials’ confidence that inflation pressures are subsiding. The monthly gauge of permanent staff salaries from the Recruitment and Employment Confederation trade body and accountants KPMG fell to 55.8 from 56.5 in December, its lowest reading since March 2021. While readings above 50 denote growth, it was some way below the survey’s pre-pandemic average of 56.7. The findings are likely to interest BoE officials, who voted this month to keep interest rates at 5.25% and indicated that the time to start cutting rates was getting nearer.   On Wednesday BoE Deputy Governor Sarah Breeden said indicators of wage growth were critically important to the outlook for interest rates. REC’s gauge of permanent staff placements also eased in January. “Pay has normalised, inflation is dropping and the hiring market has been cooling for a year now – it’s high time that the Bank of England starts releasing the brake pedal on our economy,” Neil Carberry, REC chief executive, said. Doubts surrounding the quality of official measures of the labour market have made judging the outlook for inflation and the economy more difficult for the BoE.

Senior European Central Bank (ECB) officials continued to warn against cutting interest rates too early. In an interview with the Financial Times newspaper, Executive Board member Isabel Schnabel argued against an early reduction, citing sticky services prices, a resilient labor market, and attacks on vessels in the Red Sea disrupting supply chains. Chief Economist Philip Lane said in Washington that more evidence was required before policymakers could be confident that inflation would settle at the ECB’s 2% target   In local currency terms, the pan-European STOXX Europe 600 Index ended 0.19% higher on some strong company earnings updates. However, the likelihood of interest rates staying higher for longer curbed gains. Italy’s FTSE MIB rose 1.43%, while France’s CAC 40 Index advanced 0.73%. Germany’s DAX was little changed but remained near its record high.

The private Caixin/S&P Global survey of services activity fell to a weaker-than-expected 52.7 in January from December’s 52.9 as new orders fell, although the gauge stayed in expansionary territory for the 13th straight month. (A reading above 50 indicates expansion from the prior month). The Caixin/S&P composite Purchasing Managers’ Index dipped to 52.5 from 52.6 in December as manufacturing activity remained steady in January   The consumer price index fell 0.8% in January from the prior-year period, accelerating from December’s 0.3% drop and marking its fastest decline since 2009. Food prices led the contraction as pork prices declined. Core inflation—which strips out volatile food and energy costs—rose 0.4%, its weakest rise since June 2023. The producer price index declined 2.5% from a year ago, marking the 16th consecutive month of deflation for factory gate costs   The People’s Bank of China said in its latest quarterly policy report that it would keep policy support flexible and precise to boost domestic demand. The central bank also forecast that consumer prices would “rebound modestly.” Many economists predict that Beijing will introduce further stimulus measures as the world’s second-largest economy grapples with a property market downturn, weak consumer demand, and deflationary pressures   Stocks in China rallied in a holiday-shortened week as the government’s latest raft of stimulus measures offset concerns about deepening deflation. The Shanghai Composite Index gained 4.97%, while the blue chip CSI 300 added 5.83% for the week ended Thursday. Markets in mainland China are closed for the Lunar New Year holiday from Friday, February 9, and resume trading on Monday, February 19. In Hong Kong, the benchmark Hang Seng Index rose 1.37%, according to FactSet.      
Sources: T. Rowe Price, MFS Investments, Wells Fargo, Handelsbanken Capital Markets, TD Economics, National Bank of Canada, Reuters, M. Cassar Derjavets.