Economic Outlook – 17 September 2023

The Consumer Price Index rose a consensus-matching 0.6% in August. Prices in the energy segment shot up 5.6% on gains for gasoline (+10.6%) and fuel oil (+9.1%). The cost of food, meanwhile, advanced 0.2%. The core CPI, which excludes food and energy, progressed 0.3%, overshooting the +0.2% print expected by economists. Prices for ex-energy services climbed 0.4% on gains for shelter (+0.3%), motor vehicle maintenance (+1.1%), and auto insurance (+2.4%). Airline fares (+4.9%) rose for the first time in five months, likely supported by higher jet fuel prices. The cost of core goods, instead, dipped 0.1%, marking a third consecutive decline for this indicator. Used vehicles saw another big drop (-1.2%), but this was partly offset by strong gains for medical care commodities (+0.6%) and tobacco and smoking products (+0.6%). YoY, headline inflation clocked in at a three-month high of 3.7%, up from 3.2% the prior month and one tick above the median economist forecast. The 12-month core measure, meanwhile, moved from 4.7% to a 23-month low of 4.3%. This result was in line with consensus expectations. August’s CPI report came in a tad stronger than anticipated. Although the month-on-month change in all-item CPI was in line with forecasts, the core index rose a bit more than was projected. As expected, headline prices got a sizeable boost from the energy segment, as gasoline prices rose the most since March 2022. Food prices continued to advance, but at a relatively subdued pace, a development consistent with the decline of global prices reported by the FAO index The core goods component registered its third consecutive monthly decline and was tracking a 1.9% annualized drop over the past three months. This bout of weakness reflects a host of factors, including a rebalancing of consumer demand towards services, lower international shipping costs, a loosening of supply chain constraints, and a drop in producer prices in China, which is helping drive down import prices. Above all, however, the drop in core goods inflation has been driven by a sharp slowdown in the used car sector. The explosion of financing costs observed in this market, coupled with increased supply, has already contributed to lowering prices 9.9% since their peak and further declines can be expected going forward. Moreover, while the two markets do not always evolve in lockstep, new vehicle prices to retrace as well over the next few months, albeit to a lesser extent. This should help limit the rise in goods prices going forward Retail sales advanced 0.6% in August, more than the +0.1% print expected by consensus. The prior month’s result, meanwhile, was revised from +0.7% to +0.5%. Sales of motor vehicles and parts contributed positively to the headline print, increasing 0.3% in the second month of Q3. Without autos, retail outlays rose a consensus-topping 0.6%, as gains for gasoline stations (+5.2%), clothing (+0.9%), and electronics (+0.7%) were only partially offset by declines for sporting goods (-1.6%), miscellaneous items (-1.3%), and furniture (-1.0%). Outlays in restaurants and bars progressed 0.3% on a monthly basis. Sales were up in 9 of the 13 categories surveyed. Core sales (i.e., sales excluding food services, auto dealers, building materials, and gasoline stations), which are used to calculate GDP, edged up 0.1%. Retail sales data again came in stronger than expected. However, these must be put into perspective as much of the monthly increase reflected higher prices during the month. (Recall that this week’s CPI report showed goods prices rose 1.0% in August.) In particular, gasoline stations receipts were boosted by a steep jump in pump prices. Excluding this category, retail sales increased a more subdued 0.2%. Discretionary sales, too, were much less impressive than the headline retail figure, but their 0.1% increase could hardly be described as catastrophic in light of the solid gain recorded the previous month (+0.7%). With one month of data still to come, discretionary sales are still tracking a very healthy 4.8% annualized expansion in Q3 Next week’s interest rate announcement hangs in the balance, where it is widely expected that the Federal Reserve will keep the policy rate unchanged. However, the devil will be in the details. The FOMC will also release revised economic projections, where at a minimum, they’re likely to lift the near-term growth forecast and lower the unemployment rate projection to account for the more persistent strength since the June update. The big question will be if policymakers see the near-term resilience as a source of more persistent inflationary pressures, and whether that alters the expected future path of the fed funds rate. While it is very unlikely that the FOMC would lift its terminal rate projection of 5.75% for 2023, a shallower rate cut trajectory could be signaled, reinforcing the need for rates to remain higher for longer The Empire State Manufacturing Index of general business conditions rose from -19.0 in August to 1.9 in September, above the -10.0 expected by consensus. This figure is consistent with a slight expansion in factory activity in New York State, continuing the up and- down trend that began in 2022. The shipments sub-index jumped from -12.3 to 12.4, which is consistent with increasing new orders (this sub-index climbed 25.0 to 5.1). This may explain why the work backlog sub-index increased slightly, although this indicator remained in contraction for the fifteenth time in sixteen months. Meanwhile, the delivery times sub-index crept up slightly, from 1.9 to 2.1, a second consecutive monthly expansion territory. Still, both the number of employees (from -1.4 to -2.7) and the average employee workweek (from -10.7 to -5.0) sub-indices remained in contraction. Input and output prices accelerated for the second consecutive month (the corresponding sub-indices rose from 25.2 to 25.8 and from 12.6 to 19.6, respectively), but inflation remained at levels much lower than those reached during the post-pandemic surge. The sub-index measuring business expectations for the next six months improved from 19.9 to 26.3 but remained below its long-term average of 36.2 Industrial production expanded 0.4% in August, exceeding the 0.1% gain expected by consensus. Mitigating the upside surprise, the prior month’s result underwent a downward revision from 1.0% to 0.7%. Manufacturing output (+0.1%) increased slightly on gains in durable (+0.1%) and non-durable (+0.2%) goods. On the durable goods side, gains in primary metals (+1.6%) and machinery (+2.0%) were only partially offset by a decline in motor vehicles and parts (-5.0%). Non-durable manufacturing, for its part, expanded on the back of increases in printing and support (+1.3%) and chemicals (+1.0%) which more than offset declines of apparel and leather (-3.5%), textile and product mills (-2.4%) and plastics and rubber products (-1.3%). A 1.4% increase in the mining sector’s production also contributed to the headline growth in industrial output, as did a 0.9% increase in the utilities sector The Import Price Index (IPI) swelled 0.5% m/m in August, a bigger increase than expected by economists (+0.3%). The headline print was affected by a 6.5% gain in the price of petroleum imports. Excluding this category, import prices were flat in the month. On a 12-month basis, the headline IPI was down 3.0%, up from the 4.6% pullback registered in July. The less volatile ex-petroleum gauge was down 1.1% on an annual basis, up from July’s 1.4% decline The NFIB Small Business Optimism Index slid 0.6 point to 91.3, which continued to be low on a historical basis. The net percentage of firms that expected the economic situation to improve decreased from -30% to -37%. Also, the percentage of firms that expected real sales to rise worsened from a net -12% in July to a net -14% in August. Moreover, the percentage of firms planning to increase capital spending decreased form a net 27% the previous month to 24%. On the employment front, the proportion of firms planning to hire remained steady at 17%. However, there were signs of softening in the job market: The percentage of firms not able to fill positions declined from 42% in July to 40% August, and 36% of small firms indicated that they had sweetened employee compensation in the past 3 to 6 months, down from 38% in July. However, the proportion of businesses that planned to do the same again in the coming months increased from 21% to 26%, the highest share since December 2022 The University of Michigan Consumer Sentiment index decreased from 69.5 in August to 67.7 in September. The deterioration of sentiment in September was due to a worse assessment of current (from 75.7 to 69.8) while longer-term perspectives improved (from 65.5 to 66.3). Twelve-month inflation expectations decreased from 3.5% to 3.1%, while 5/10-year expectations slipped from 3.0% to 2.7% The Producer Price Index for final demand advanced 0.7% in August, surpassing the 0.4% increase expected by the consensus. Goods prices were up 2.0% as energy surged 10.5%, while food decreased 0.5%. Prices in the services category, meanwhile, rose 0.2%. The core PPI, which excludes foods and energy, increased 0.2% in the month, as expected by economists. YoY, the headline PPI went from +0.8% to +1.6%, a still-low level since the end of 2020. Excluding foods and energy, it decreased from +2.4% to +2.2%, a multi-month low Saying no one wins in a government shutdown, Speaker of the US House of Representatives Kevin McCarthy vowed to avoid a closure when the US government’s fiscal year comes to an end on 30 September. McCarthy faces infighting among his Republican caucus over issues such as border security and reining in soaring deficits. This week McCarthy also announced that the House has launched an impeachment inquiry over President Joe Biden’s involvement in his son Hunter Biden’s overseas business dealings The United Autoworkers contract with Detroit’s Big Three automakers expired at midnight Thursday, precipitating the first-ever UAW strike against the three companies. Workers walked out of a few plants on Friday as the strike began The major equity indexes finished mixed, with value stocks leading the market as U.S. benchmark West Texas Intermediate oil prices rose above $90 per barrel for the first time since November 2022. Large-cap shares outperformed small-caps. Technology and growth stocks lagged after Apple’s new product introduction event on Tuesday that featured a price increase on its top-of-the-line iPhone 15. The products received mixed reviews, which also seemed to dampen sentiment toward the technology sector over the course of the week. However, broad market sentiment received a boost from the largest initial public offering of 2023 as shares of a UK microchip designer started trading on the Nasdaq on Thursday and experienced a first-day price jump In terms of data release, housing start is out on Tuesday. The housing market remains under pressure amid elevated mortgage rates and still-high prices. Yet, new construction has seen somewhat of a bounce recently. Total housing starts rose 3.9% to a 1.45-million-unit pace in July. Single-family construction continues to be propelled by a sturdy stream of buyers who have become disenchanted with the resale market where inventory is low and prices are high. By contrast, a more challenging lending environment and robust pipeline of incoming apartment supply looks to be discouraging multifamily developers from moving forward with new projects. The divergence between solid single-family construction and lagging multifamily thus continues The Leading Economic Index is out on Thursday. If it were up to the Leading Economic Index (LEI), the U.S. economy would already be in contraction. The index is now 5% below its pre-pandemic February 2020 level and the six-month average change has been below a threshold historically consistent with recession for 13 months. It’s not just one component of the index leading it lower either. If you exclude the components of persistent weakness, like consumer expectations or the interest rate spread, the index continues to signal contraction.  

July’s monthly GDP number, out this morning, shows a significant negative print. MoM GDP was -0.5%, reversing monthly growth observed in June and under market expectations of -0.2%. The main contributor to the economic contraction was a fall in services output by 0.5%. It is thought that the poor weather affected the retail sector, but another one of the key factors behind this was a considerable fall in human health and social work activities (down 2.1% in July), which saw industrial action from senior doctors, radiographers and junior doctors. Other service sectors including information and communication and administrative support service activities also saw a notable drop-in activity along with many non-service sectors. In July, production output was down 0.7%, manufacturing by 0.8%, and construction output by 0.5% in volume terms The release reconfirms the Office for National Statistics’ (ONS) previous revision to UK growth in 2020 and 2021, with estimates now that in December 2021, the UK economy was 0.9pp above its 2019 level rather than the original estimate of it being 0.2pp below. It has been thought for some time that, since the onset of the pandemic, the UK economy has been the laggard for growth in the G7, but the revised data would imply that growth rates have roughly been in line with France and Japan, and have been considerably stronger than those in Germany. However, growth rates in the US and Canada have dramatically exceeded those observed in the UK Annual growth in employees’ average total pay (including bonuses) registered at 8.5% in May to July, an advance from a revised figure of 8.4% in the previous month and exceeding market expectations of just 8.2%. This is the largest annual growth rate seen outside the covid period, although the figures have been skewed by one-off payments made by the NHS and civil service in June and July. Average annual regular private sector wages, which are watched closely by the Bank of England, were 8.1% compared to 6.6% in the public sector. As a result of the strong nominal pay figures and falling inflation real pay has edged further into positive territory, now registering at 1.2% on the year for total pay The UK labour market continues to show some signs of loosening, both on the supply and demand side. Vacancy levels in the economy have now dropped below 1 million, decreasing by 64,000 in June to August 2023 compared to the previous quarter. The UK’s unemployment rate ticked up to 4.3%, as expected, meaning that the rate is now 0.5pp higher than the previous quarter. There has been an increase in inactivity in June to August, although the jump is largely accounted for by a 55,000 increase in students compared to the previous month. However, economic inactivity will remain a concern to policymakers given there are 410,000 additional inactive people in the UK compared to pre-pandemic levels. This trend has not been observed in other G7 countries The UK’s FTSE 100 Index climbed 3.12%, helped by the depreciation of the UK pound versus the U.S. dollar. A decline in the UK currency helps to support the index, which includes many multinational companies that generate meaningful overseas revenue.

ECB hikes 25 basis points to 4 percent as inflation fears persist. While the decision to hike was in line with expectations, investors were cautious and economists were almost evenly split on the outcome, in what was called a razor-edge decision between a “dovish” hike and a “hawkish” pause. While there were members that would have preferred a pause, Lagarde commented that there was a solid majority for the decision to hike. In its motivation the ECB repeated the June statement that “Inflation continues to decline but is still expected to remain too high for too long”. It is likely that rates have now peaked at 4 percent. This is supported by the statement by the Governing Council that “ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target”. Although this does not rule out further interest rate hikes, and the ECB reiterates that it will continue to follow a data-dependent approach, it contrasts to the June statement that “future decisions will ensure that the key ECB interest rates will be brought to levels sufficiently restrictive”.   The ECB September macro forecast (ECB June forecast in brackets) implies headline inflation in 2023, 2024 and 2025 to average 5.6% (5.4%), 3.2% (3.0%) and 2.1% (2.2%), and for core inflation to average 5.1% (5.1%), 2.9% (3.0%) and 2.2% (2.3%). The upward revision for headline 2023 and 2024 mainly reflects a higher path for energy prices. GDP is set to grow by 0.7% (0.9%) in 2023, followed by 1.0% (1.5%) in 2024 and 1.5% (1.6%) in 2025. The lower economic growth projections reflect the increasing impact of tightening on domestic demand and the weakening international trade environment. Lagarde also clarified that the lower GDP growth in 2024 largely reflects carry-over from downward revisions to the second half of 2023. while growth is expected to resume during 2024 In local currency terms, the pan-European STOXX Europe 600 Index ended 1.60% higher after the European Central Bank (ECB) raised interest rates but signaled that borrowing costs may have reached a peak. Better economic data out of China also appeared to lift investor sentiment. Germany’s DAX added 0.94%, France’s CAC 40 Index gained 1.91%, and Italy’s FTSE MIB tacked on 2.35%.   

Official data for August provided evidence of economic stabilization in the country. Industrial production and retail sales grew more than forecast last month from a year earlier, while unemployment unexpectedly fell from July. However, fixed asset investment growth missed forecasts due to a steeper decline in real estate investment. New bank loans rose an above-consensus RMB 1.36 trillion in August, up from July’s RMB 345.9 billion. Credit expansion was mostly driven by corporate demand, while household and longer-term loans also grew Inflation data revealed that consumer prices returned to growth after slipping into contraction in July. The consumer price index rose 0.1% in August from a year earlier, up from July’s 0.3% decline. Meanwhile, the producer price index fell 3% from a year ago as expected but eased from the 4.4% drop the previous month. The inflation readings provided more evidence that the worst may be over for China’s slowing economy, which led Beijing to issue a flurry of stimulus measures in recent weeks aimed at jumpstarting demand In monetary policy news, the People’s Bank of China (PBOC) cut its reserve ratio requirement by 25 basis points for most banks for the second time this year to inject more liquidity into the financial system. The central bank also rolled out RMB 591 billion into the banking system compared with RMB 400 billion in maturing loans. Many economists predict that the PBOC will engage in further policy easing for the rest of 2023 as the government tries to boost China’s post-pandemic economy, which has been losing momentum following a brief first-quarter rebound Chinese equities were mixed after official indicators revealed that the country’s economy may have bottomed, although data also pointed to ongoing weakness in the property market. The Shanghai Composite Index ended the week broadly flat while the blue-chip CSI 300 Index gave up 0.83%. In Hong Kong, the benchmark Hang Seng Index shed 0.1%, according to Reuters.            
Sources: T. Rowe Price, MFS Investments, Wells Fargo, National Bank of Canada, Reuters, TD Economics, M. Cassar Derjavets.