Economic Outlook – 15 January 2023

The Consumer Price Index edged down 0.1% in December, the indicator’s first decline in five months. The result was in line with consensus expectations. Prices in the energy segment dropped 4.5% as declines for fuel oil (-16.6%) and gasoline (-9.4%) were only partially offset by a 3.0% gain for utility gas services. The cost of food, meanwhile, progressed 0.3%, a healthy advance to be sure, but nevertheless the weakest since 2021M03. The core CPI, which excludes food and energy, rose a consensus-matching 0.3%. Prices for ex-energy services progressed 0.5% as another strong gain for shelter (+0.8%) was compensated for in part by a 3.1% drop in airline fares. Motor vehicles maintenance (+1.0%) and insurance (+0.6%) continued to advance at a brisk clip, while the cost of medical care services inched up 0.1%. The cost of core goods, meanwhile, dropped 0.3% on a monthly basis on another sharp decline for used vehicles (-2.5%). The price of new vehicles and tobacco/smoking products also weighed on the core goods index, as they both eased 0.1%. The cost of apparel and alcoholic beverages, on the other hand, rose 0.5%. Yoy, headline inflation clocked in at a 14-month low of 6.5%, down from 7.1% the prior month. The 12-month core measure eased from 6.0% to 5.7%, its lowest mark in a year The University of Michigan Consumer Sentiment Index rose from 59.7 in December to a still depressed 64.6 in January. The increase was due to an improvement in both current perspectives and longer-term ones. The former improved from 59.4 to 68.6, while the latter increased from 59.9 to 62.0. Twelve-month inflation expectations decreased from 4.4% in December to 4.0% in January, its lowest print since April 2021 Import prices increased 0.4% in December, as the consensus was expecting a 0.9% decline. This was the first positive print in six months for this indicator. This unanticipated increase was slowed by a 2.7% drop in the price of oil imports. Excluding this category, prices increased 0.8%. On a 12-month basis, the headline IPI increased from 2.7% to 3.5%. The ex-petroleum gauge climbed from 2.0% to 2.4%. In December, the NFIB Small Business Optimism Index pegged in at 89.8, down 2.1 percentage points from November and way below the index’s long-term average. Consensus expectations were for the index to notch down to 91.5. The deterioration stemmed from a decrease in eight of the ten components of the index. Notably, the net earnings trend dropped 8 percentage points further into negative territory to -30% After last week’s payrolls report, investors were eager to see the December reading on U.S. CPI to better gauge the future path of the policy rate. Going into the week, most market participants expected a further downshift in the pace of rate hikes when the FOMC next meets in early-February. Inflation is (finally) moving in the right direction, solidifying market pricing for a 25-bps hike. Equities were up 2% on the week, while the U.S. 10Y fell by roughly 10-bps and currently sits at 3.45% Senior White House officials confirmed this week that US Secretary of the Treasury Janet Yellen will remain in her post for a third year. It is not unusual for cabinet officers to leave their positions after the midterm elections. Yellen drew criticism earlier in Biden’s term for her belief that inflation would be transitory, a mistake that she has acknowledged. With the prospect of a looming fight over the nation’s debt limit in Congress, Yellen, a former Fed chair, is well-placed to warn against the perils of a potential default The Federal Reserve Bank of New York’s December Survey of Consumer Expectations found that one-year-ahead inflation expectations declined to 5%, the lowest reading since July 2021. Household spending expectations declined sharply to 5.9% in December from 6.9% in November while income growth expectations rose to 4.6%, a series high. The US budget deficit widened 12% in the first quarter of the fiscal year as interest payments on the national debt soared 37%. From October through December, the deficit reached $421 billion. The budget gap for 2022 came in at $1.38 trillion, down from $2.78 trillion the prior year during some of the worst of the pandemic Stocks recorded a second consecutive week of gains as investors weighed key inflation data and quarterly earnings reporting season kicked off in earnest on Friday. The Nasdaq Composite and growth-oriented sectors outperformed, helped by rebounds in some mega-cap technology-related names, including, Tesla, and Microsoft. Consumer staples shares lagged. JPMorgan Chase, Wells Fargo, and Bank of America beat consensus expectations when they released earnings Friday morning, but cautious outlooks from the banking giants caused shares to fall in early trading In terms of data release, retail sales is out on Wednesday. Nominal retail sales declined by 0.6% in November, the largest monthly drop of 2022. Inflation-adjusted retail sales declined 0.3% over the month. Consumers have shown incredible resolve in the face of higher inflation and rising borrowing costs in 2022, but there are hints that may be changing. While one data point does not make a trend, the composition of November’s spending slowdown suggests that high financing costs may be weighing heavy on consumers. Furniture and autos, two categories traditionally funded by credit, took the biggest hit Industrial Production print is also out on Wednesday. Broad-based declines in industrial production suggest that producers are pulling back in response to weakening demand for goods. The industrial production index dropped 0.2% in November, the steepest monthly drop in more than a year. The important manufacturing subindex experienced declines in both durable and nondurable manufacturing (-0.6% each). Of note, motor vehicle and parts production dropped 2.8%, adding to evidence that consumers are feeling the weight of higher financing costs. But production in other sectors also retreated. Mining output fell 0.7% for the second straight month. Oil and gas drilling similarly fell 0.7%, only the second time this index has declined over the past 28 months 

GDP and trade figures for November have come out. Monthly GDP was +0.1% MoM and +0.2% YoY. These figures cover the critical pre-Christmas period and while retail sales have shot up (in particular online sales), while the forecast remains that overall GDP is still set to fall over the course of 2023. The biggest negative contribution came from transportation and storage, down by -2.3% largely on the back of strike activity. While the monthly figure is up, critically the three months through November still saw a decline in overall GDP of -0.3%. Output in consumer-facing services grew by 0.4% in Nov, following growth of 1.5% in Oct; the largest contribution to growth came from food and beverage service activities, attributable to the World Cup (the boost should be seen in next month’s figures as well). There is plenty of bad news baked into the UK economic outlook, and while much of it is pragmatic, there are signs of hope, chiefly that the winter is so far proving milder than anticipated, and much of the expected downturn and consequential squeeze on incomes is due to anticipated high energy prices. For the moment UK consumers are still increasing savings and the majority are still unwilling to use their pandemic-accumulated savings to meet everyday cost-of-living expenses Bank of England (BoE) Chief Economist Huw Pill said in New York that the UK faced the risk of persistent inflation, hinting that interest rates would probably rise again. “The distinctive context that prevails in the UK—of higher natural gas prices with a tight labor market, adverse labor supply developments and goods market bottlenecks—creates the potential for inflation to prove more persistent,” Pill stated, which would “strongly influence my monetary policy position in the coming months.” Financial markets expect the BoE to raise its key interest rate by half a percentage point (0.50%) to 4.00% in February.  

In the Eurozone, the unemployment rate in November stood at 6.5%, in line with consensus expectations. The unemployment rate fell from 12.5% to 12.4% in Spain, from 7.9% to 7.8% in Italy, and from 7.1% to 7.0% in France but held steady in Germany at 3.0%The German economy likely stagnated in the fourth quarter of 2022, after growing 0.4% in the previous three months, according to a first estimate from the national statistics office. The Finance Ministry said the data pointed to a milder, shorter slowdown over the winter. For the full year, the economy expanded 1.9%, down from 2.6% in 2021, as the Russia-Ukraine war and surging energy costs curbed output. Meanwhile, the German Chambers of Commerce and Industry said that more than half of Germany’s companies were suffering from labor shortages Shares in Europe rallied for a second consecutive week, as better-than-expected economic data raised hopes of a short and shallow recession. However, some central bankers said interest rates would need to rise further, tempering market optimism. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.88% higher. Major stock indexes rose strongly. Germany’s DAX Index climbed 3.26%, Italy’s FTSE MIB Index advanced 2.40%, and France’s CAC 40 Index added 2.37%   

China’s inflation gained momentum, rising 1.8% in December. Core inflation, which excludes food and energy prices, picked up slightly after remaining unchanged for three consecutive months. Meanwhile, producer prices weakened as virus-related disruptions curbed industrial demand. The producer price index declined 0.7% in December after falling 1.3% in November China issued a large quota for crude oil imports to prepare for an expected uptick in energy demand as infections start to wane and economic activity returns to normal. Economists polled by Reuters projected a swift rebound for China’s economy once infections peak and forecast 4.9% growth this year versus an estimated growth pace of about 3% in 2022. China’s exports fell 9.9% in December from a year ago as global demand softened and rising infections disrupted activity after the government rolled back pandemic restrictions. Imports fell a better-than-expected 7.5%. For the full year, China’s trade surplus reached an all-time high of USD 878 billion as strong export growth for most of 2022, a weak yuan, and the rising price of goods boosted the value of exports Chinese stocks rose as a softer-than-expected U.S. inflation print and optimism about the post-pandemic reopening outlook boosted sentiment. The Shanghai Composite Index gained 1.19% and the blue chip CSI 300 advanced 2.35%, a four-month high   
Sources: T. Rowe Price, MFS Investments, Wells Fargo, TD Economics, Handelsbanken Capital Markets, National Bank of Canada, M. Cassar Derjavets