Economic Outlook – 19 March 2023

The Consumer Price Index progressed 0.4% in February, in line with consensus expectations. Prices in the energy segment retreated 0.6% as an increase for gasoline (+1.0%) was more than offset by steep declines for fuel oil (-7.9%) and utility gas services (-8.0%). The cost of food, meanwhile, rose 0.4%, marking its smallest progression in nearly two years. The core CPI, which excludes food and energy, advanced 0.5%, one tick more than the median economist forecast calling for a print of +0.4%. Prices for ex-energy services rose 0.6% as another massive increase for shelter (+0.8%) was compensated for in part by a record decline in the medical care category (-0.7%). Motor vehicles maintenance (+0.2%) and insurance (+0.9%) advanced at a slower pace, while airline fares jumped 6.4%. The cost of core goods stayed unchanged on a monthly basis, hampered by another sharp decline for used vehicles (-2.8%, the second biggest monthly drop since 2003). Alternatively, notable increases were recorded for tobacco and smoking products (+1.0%) and apparel (+0.8%). Prices in the alcoholic beverages segment went down 0.3% The core goods component remained tepid, with the used car category acting as a drag once again. On the services side, the data published were more mixed. The medical care component continued to slump but this was likely not due to any real weakness. Instead, the drop in prices reflected a methodological quirk linked to how out-of-pocket insurance costs are calculated by the BLS. This oddity should translate into weak prints going forward, but these will in no way be indicative of the underlying inflation trend The Producer Price Index for final demand dipped 0.1% in February instead of climbing 0.3% as per consensus. Adding to the surprise, the prior month’s result was revised downward from +0.7% to +0.3%. Goods prices fell 0.2% on declines for both food (-2.2%) and energy (-2.2%). Prices in the services category, meanwhile, edged down 0.1%, marking only the second monthly drop in this segment in more than two years. The core PPI, which excludes food and energy, stayed flat in the month; economists had anticipated a 0.4% gain. YoY the headline PPI sank from 5.7% to 4.6%, its lowest level since March 2021. Excluding food and energy, it tumbled from 5.0% to a 23-month low of 4.4% The Import Price Index (IPI) retraced 0.1% MoM in February, which was less so than expected by economists (-0.2%). The headline print was positively affected by a 1.5% rise in the price of petroleum imports, which means that, excluding this category, import prices fell at a steeper pace (-0.4%). On a 12-month basis, the headline PPI sank into deflation territory for the first time since 2020, plunging from +0.9% to -1.1%. The less volatile ex-petroleum gauge slid from 1.4% to a 32-month low of 0.2% Retail sales contracted a consensus-matching 0.4% in February. Sales of motor vehicles and parts fell 1.8%, erasing only a fraction of the prior month’s gain (+7.1%). Without autos, retail outlays edged down 0.1% as increases for non-store retailers (+1.6%), health and personal care items (+0.9%), general merchandise (+0.5%), and food beverages (+0.5%) were more than offset by declines for furniture (-2.5%), eating/drinking establishments (-2.2%), miscellaneous items (-1.8%), and clothing (-0.8%). In all, sales contracted in 8 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, progressed 0.5% and were tracking a massive 9.0% annualized gain in Q1 as a whole. This suggests that goods consumption will contribute strongly to GDP growth in the first quarter of the year. Based on the restaurants and bars category (the only services segment covered in the retail report), services consumption, too, should be strong in Q1 Industrial production stayed unchanged on a monthly basis in February, a result weaker than the median economist forecast calling for a +0.2% print. This disappointment was compensated by an upward revision of the previous month’s result, from +0.0% to +0.3%. After advancing 1.3% the prior month, manufacturing output crept up 0.1% in February on gains for both durable (+0.1%) and non-durable (+0.2%) goods. Looking at the subcategories, computer/electronics (+1.2%), chemical products (+1.2%) and wood products (+1.1%) were the biggest winners, while plastic/rubber products (-1.8%), paper products (-0.9%) and petroleum/ coal products (-0.4%) saw declines. Production in the motor vehicles segment slipped 0.3%. Utilities output, meanwhile, rose 0.5%, erasing only a small portion of the prior month’s decline (-10.1%). Finally, production in the mining sector fell 0.6% Homebuilder sentiment, meanwhile, rose for the third month in a row in March, as measured by the National Association of Home Builders Market Index, which rose 2 points to 44. Moreover, the NAHB gauge tracking prospective buyer traffic climbed from 28 to 31 to signal a slight improvement in this regard In a major policy reversal, US President Joe Biden this week approved a massive oil drilling project on Alaska’s North Slope. Over time, the Willow Project is expected to produce 600 million barrels of oil. Environmental groups were united in their condemnation of the plan which they believe conflicts with Biden’s climate goals The NFIB Small Business Optimism Index edged up 0.6 point in February to a still depressed 90.9. The net percentage of firms that expected the economic situation to improve sank deeper into negative territory, moving from -45% to -47%, one of the lowest prints ever recorded. Net sales expectations, on the other hand, improved somewhat (from -14% to -9%), but this did not prevent a decline in hiring intentions (from 19% to a joint two-year low of 17%). Hiring in February was limited by difficulty finding good candidates: 47% of businesses reported not being able to fill one or more vacant positions. In an effort to attract qualified workers, 46% of small firms said they had sweetened employee compensation in the past 3-6 months, a percentage just shy of the record established early last year (50%). However, with margins squeezed by higher input and financing costs, fewer businesses planned to do the same again in the coming months (23%) The University of Michigan Consumer Sentiment index fell from 67.0 in February to 63.4 in March. The survey was conducted between February 22 and March 15, which means that roughly 85% of interviews had been completed before the failure of Silicon Valley Bank. It would therefore not be surprising if the final estimate – due for publication on March 31 – is revised downwards. The deterioration of sentiment in March was due in part to a worsening of assessment of current conditions, with the associated index dropping from 70.7 to 66.4. Longer term perspectives also fell, with the sub-index tracking future expectations retreating from 64.7 to 61.5. Twelve-month inflation expectations eased from 4.1% to a 23-month low of 3.8%, while 5/10-year expectations edged down from 2.9% to 2.8% The Empire State Manufacturing Index of general business conditions plunged 18.8 points in March to -24.6, the third lowest level since March 2009 outside the first months of the pandemic. It was also significantly below consensus expectations calling for a -7.9 print. Moreover, it was indicative of a sharp deterioration in operating conditions at factories in New York State and surrounding areas in a context of slowing demand and bloated inventories. After signaling a marginal expansion in the prior month, the shipments sub-index dropped 13.5 points to -13.4. The new orders tracker sank as well, moving from -7.8 to -21.7, one of the lowest prints recorded in data going back to 2000. As demand remained depressed, unfilled orders (from -9.2 to -6.7) contracted for the tenth month in a row, while employment (from -6.6 to -10.1) shrank the most since the early days of the pandemic. Supply chain pressures continued to ease, as measured by the delivery times sub-index (from -9.2 to -7.6), which remained below the 0 mark separating expansion from contraction. Input prices (from 45.0 to 41.9) and output prices (from 28.4 to 22.9) continued to advance, albeit at a slower pace than in the prior month The Philly Fed Manufacturing Business Outlook Index painted a similarly downbeat picture of the situation prevailing in the manufacturing sector. Despite a slight increase in March (from -24.3 to -23.2), the index came in well below consensus expectations (-15.0) and continued to signal a sharp deterioration of operating conditions. Outside of the pandemic period, new orders (from -13.6 to -28.2) and shipments (from 8.7 to -25.4) contracted at the fastest pace since March 2009, while payrolls (from 5.1 to -10.3) shrank the most since 2016. Supplier delivery times (from -13.6 to -24.3) shortened at the fastest clip since the great Recession and input price inflation (from 26.5 to 23.5) was the weakest since August 2020. The prices received gauge (from 14.9 to 7.9), meanwhile, fell below its pre-pandemic levels, signaling a rapid moderation in price pressure in the manufacturing sector The Conference Board’s index of leading economic indicators (LEI) declined for a tenth straight month in February, sliding 0.3 point to a 2-year low of 110.0. Six of the ten underlying economic indicators acted as a drag on the headline index, with the biggest negative contributions coming from average consumer expectations (-0.24 pp) and ISM new orders (-0.19 pp). building permits, on the other hand, contributed 0.39 pp to the headline figure. Historical analysis shows that an annualized drop of 3.5% in the LEI index over six months, coupled with a six-month diffusion index below 50%, is generally symptomatic of a pending recession. These conditions were met in February: The index dropped 7.1% annualized over six months and the six-month diffusion index stood at 20% In an effort to allay depositor fears and reassure financial markets, the FDIC, Federal Reserve, and U.S. Treasury implemented a rescue plan over the weekend. Deposit insurance for all deposits over $250k was extended, while a Bank Term Funding Program was also established, allowing all depository institutions to borrow at the Fed at a low rate using standard collateral. Moreover, the collateral could be valued at par rather than “marked to market” as is the case with other Fed liquidity facilities. Not only will this increase the amount of capital that troubled banks can access, but it will also prevent institutions from having to sell assets at significant losses, which should help to shore up confidence and stem the tide on further deposit outflows On Thursday morning, a group of eleven of the largest banks in the United States, after some prodding from the US government, organized a rescue plan for First Republic Bank, a San Francisco-based lender whose business model somewhat resembles that of Silicon Valley Bank, which is now in FDIC receivership. Under the plan, the group will deposit $30 billion with First Republic for an initial period of 120 days. After Thursday’s close, First Republic’s board of directors announced it had suspended the dividend on its common stock The major indexes closed mixed for the week, reflecting the crosscurrents of stresses in the banking sector, worries that a steeper slowdown in the economy would follow, and hopes that the Federal Reserve would now be forced to moderate or even pause in its rate-hiking cycle. Relatedly, sector returns within the S&P 500 Index varied widely, with communication services and technology shares recording strong gains, while financials and energy shares suffered significant losses. The mega-cap tech shares that generate significant free cash flow and have minimal exposure to the regional banks performed especially well, and large-cap growth stocks outperformed their value counterparts by 580 basis points (5.80 percentage points), according to Russell indexes In terms of data release, the existing / new home sales prints are out on Tuesday and Thursday. January marked 12 consecutive months of waning existing home sales, a consequence of the Fed’s year-long bout of monetary tightening. The housing market began to stabilize at the beginning of the year as lower mortgage rates brought buyers back from the sidelines. January’s 0.7% dip in existing home sales was less than half of the prior month’s decline (-2.2%) and the mildest drop recorded in 12 months. Housing market stabilization was also evidenced by two consecutive monthly increases in pending home sales alongside a 10.6% bump in mortgage applications for purchase across December and January Durable goods orders are out on Friday. Durable goods orders declined 4.5% in January, which was largely anticipated payback from December’s 5.1% jump. This volatility was entirely driven by aircraft orders, which slid 55% in January after surging 106% the month prior. Cutting through the noise reveals resilience in capital expenditures in January that was largely consistent with the positive consumer and labor market data observed at the start of the year. Core capital goods orders ticked up 0.8% in January, the largest bump since August 2022.

UK employment and earnings figures for January came out this morning. The unemployment rate has risen to 3.7% (consensus 3.8%), the claimant count for February rising to -11.2k (last month 30.3k). This latter number suggests that, while further rises to the overall unemployment in coming months can be expected, the number of vacancies is declining and thus rises to unemployment are likely to be subdued. The employment picture in the UK has been broadly positive. The UK employment rate was estimated at 75.7% in November 2022 to January 2023, 0.1 percentage points higher than the previous quarter, largely driven by part-time and self-employed workers. Data from the United States suggests that there have been significant numbers of older workers retiring and, while there have been some older Americans who have decided to return to the labour market, overall, the decline seen in the working population trend has kept the labour market tight. It is very likely that something similar is being seen in the UK. Given that approximately 20% of UK households where the couple is over 65 have over one million in accumulated savings, the temptations of retirement are proving highly attractive. Moreover, there is a significant disincentive for better off older workers, in that contributions to their pension accounts can easily attract marginal income tax rates well above 50% once they have accumulated one million in pensionable savings. The Chancellor in tomorrow’s budget is rumoured to be set to radically raise the limits on pensionable savings by as much as GBP 500k in an effort to entice older workers (particularly NHS doctors) back to work The forecast for the UK economy over the course of 2023 has been getting steadily better in recent months, to the point where the Chancellor has announced that the (independent) Office for Budget Responsibility now forecasts that the UK will not see a technical recession this year. This means there is an expectation that the UK will not see two consecutive quarters of negative growth.  The Chancellor was also pleased to announce that inflation will be more than halved, largely due to significant falls in energy costs. This decline in inflation is largely due to the winter being milder than anticipated and as a result the Government Energy Price Guarantee has been far less expensive than anticipated (the forecast cost for Q1 2023 in Aug 22 had been GBP 12.8bn, in actuality it will cost GBP 1.5bn), the price guarantee has also been extended from the end of April to the end of July, although falling energy prices means the price cap is unlikely to be breached from June onwards. The expectation that inflation is due to fall faster than anticipated, to 2.9% by year end, will lessen the pressure on the Bank of England to raise interest rates at its March 23 meeting.

The Governing Council decided to raise its policy rates by 50bp repeating last meeting’s statement that “inflation is projected to remain too high for too long”. As for recent concerns over financial stability, the press release stated that: “The Governing Council is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area. The euro area banking sector is resilient, with strong capital and liquidity positions. In any case, the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy.” As in the previous meeting’s press release,  the APP portfolio will decline at a pace of “EUR 15 billion per month, on average, until the end of June 2023 and its subsequent pace will be determined over time.” Shares in Europe tumbled on fears sparked by strains in the financial system. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 3.84% lower. Major stock indexes also fell. France’s CAC 40 Index shed 4.09%, Germany’s DAX Index declined 4.28%, and Italy’s FTSE MIB Index gave up 6.55%.

New home prices in 70 of China’s largest cities rose 0.3% in February, above the 0.1% gain in January and marking the fastest increase since July 2021, according to the National Bureau of Statistics. China’s real estate market has been in a downturn in recent years as cash-strapped property developers have struggled with slowing sales and high debt levels. However, the sector has recovered significantly in recent months, bolstered by Beijing’s dismantlement of its zero-COVID policy in December New bank loans reached a higher-than-expected RMB 1.81 trillion in February compared with January’s record RMB 4.9 trillion. Though credit expansion typically slows in February, China’s accommodative policy and post-COVID recovery led to a pickup in economic activity last month The People’s Bank of China (PBOC) said it will cut the reserve requirement ratio (RRR) for most banks by 25 basis points for the first time this year in a bid to ensure liquidity and boost the economy. The central bank last cut the RRR in December by the same magnitude. Separately, the PBOC injected a greater-than-expected RMB 481 billion into its financial system via its one-year medium-term lending facility, compared with RMB 200 billion in maturing loans. The central bank left the medium-term lending rate unchanged, as expected The moves follow PBOC Governor Yi Gang’s surprise reappointment for another term after he was widely expected to retire. Yi’s retention appeared to have a calming effect on markets following the revamp of central government institutions under the State Council, China’s cabinet, in the prior week. Some analysts viewed Yi’s reappointment as a desire to maintain financial stability as China prioritizes supporting the economy amid rising growth headwinds Chinese stocks ended a volatile week on a mixed note as global banking woes offset optimism about an economic recovery and further monetary support from Beijing. The Shanghai Stock Exchange Index added 0.63%, and the blue-chip CSI 300 Index fell 0.21% in local currency terms. In Hong Kong, the benchmark Hang Seng Index added 1%        
 Sources: T. Rowe Price, MFS Investments, Wells Fargo, Handelsbanken Capital Markets, National Bank of Canada, M. Cassar Derjavets