Economic Outlook – 22 January 2023

Retail sales were down 1.1% in December. Economists were expecting them to decline 0.9%. Adding to the disappointment, November’s sales growth was revised down from -0.6% to -1.0%. Sales of motor vehicles/parts contributed negatively to the headline print, contracting 1.2%. Without autos, retail outlays retreated 1.1% as small gains for building materials (+0.3%) and sporting goods (+0.1%) were more than offset by steep declines for gasoline stations (-4.6%), furniture (-2.5%), non-store retailers (-1.1%), miscellaneous items (-1.1%), and restaurants/bars (-0.9%). Sales were down in 10 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, retraced 0.7% Retail sales came in below consensus expectations in December, dropping at the fastest pace in a year. Part of the decline was due to the automotive sector, which suffered from lower prices and reduced demand in a higher rate environment. Gasoline stations receipts also fell, but this was expected in the light of plunging pump prices. However, even excluding these two categories, outlays still contracted 0.7%, with a clear majority of surveyed categories moving down. Lower spending in restaurants and bars was another cause for concern, as it points to at a weak showing for services consumption in the month. It is worth noting, though, that December’s results were probably affected by poor weather conditions. During the holiday season, the United States was hit by several adverse weather events, including historic snowstorms and severe cold snaps. These likely weighed on household spending during the crucial Christmas period, as evidenced by a 6.6% drop in outlays at department stores. Be that as it may, December’s disappointing result will translate into a weaker contribution from goods consumption to Q4 GDP growth than previously expected, as core sales advanced just 1.9% annualized in the final three months of 2022 Industrial production shrank 0.7% in December, which was way more than the 0.1% decline expected by consensus. What’s more, the prior month’s result underwent a significant downward revision from -0.2% to -0.6%. After retreating 1.1% in November, manufacturing output slumped 1.3% in the final month of 2022, marking the sharpest two-month contraction since 2009M04 (outside of the pandemic lockdown). Output declines were recorded in December for both durable goods (-1.1%) and nondurable goods (-1.5%). Regarding durables, most major industries posted declines of at least 1%, with machinery (-3.4%) and wood products (-2.1%) registering particularly severe losses. Auto output fell 1.0%. Regarding non-durables, all major segments showed declines, led by printing (-3.4%) and petroleum/coal products (-3.1%). Utilities output jumped 3.8% as colder-than-usual temperatures stimulated electricity demand. Finally, production in the mining sector pulled back 0.9% The Empire State Manufacturing Index of general business conditions plunged 21.7 points in January to -32.9, its lowest level since March 2009 outside the first months of the pandemic. It was also significantly below consensus expectations calling for a -8.7 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 progressing in December, the shipment subindex declined abruptly from 5.3 to -22.4. The new orders tracker sank as well, moving from -3.6 to -31.1, its fourth lowest print in data going back to 2000. As demand evaporated, unfilled orders contracted the most since the early days of the pandemic (from -11.2 to -14.3). The number of employees tracker slid as well (from 14.0 to 2.8) but held just above the 0 mark separating expansion from contraction, a development inconsistent with a steep contraction in the average workweek (from -4.5 to -10.4). Supply chain pressures continued to ease with the delivery times tracker (from 1.9 to 0.9) remaining near 0 for the sixth month running. Input prices (from 50.5 to 33.0) and output prices (from 25.2 to 18.8) continued to advance, albeit at the weakest pace in two years. One of the few bright spots in the report was the improvement in business expectations for the next six months (from 6.3 to 8.0) The Philly Fed Manufacturing Business Outlook Index painted a slightly more optimistic picture of the situation prevailing in the manufacturing sector as it rose from -13.7 in December to a still depressed -8.9 in January. New orders (from -22.3 to -10.9) continued to contract, albeit at a slower pace than in the prior month, while shipments (from -0.9 to 11.1) and employment (from -0.9 to 10.9) swung back into expansion territory. Supplier delivery times (from -7.2 to -5.6) shortened for the sixth time in seven months and input price inflation (from 36.3 to 24.5) was the weakest since August 2020. The index tracking future business activity improved from -0.9 to a nine-month high of 4.9 The Producer Price Index for final demand sank 0.5% in December, a bigger decline than the 0.1% pullback expected by consensus. Goods prices dropped 1.6%, led by declines in both the energy segment (-7.9%) and the food segment (-1.2%). Prices in the services category, meanwhile, crept up 0.1%, the weakest increase in eight months. The core PPI, which excludes food and energy, increased 0.1%, in line with analysts’ expectations. YoY, the headline PPI slid from 7.3% to 6.2%, its lowest level since March 2021. Excluding food and energy, it slipped from 6.1% to a 19-month low of 5.6% Housing starts retreated from 1,401K in November (initially estimated at 1,427K) to 1,382K in December, which was still above the median economist forecast of 1,358K units. The decline was entirely due to a 19.0% drop in the multi-family segment to a 15-month low of 473K. Ground breaking in the single-family category increased 11.3% to 909K Homebuilder sentiment, meanwhile, seems to be stabilizing at a low level. In January, the National Association of Home Builders Market Index rose 4 points to 35. NAHB data also signaled a slight improvement in prospective buyer traffic, with the associated gauge climbing from 20 to 23 After 10 consecutive declines from January to November, existing home sales slipped another 1.5% in December to 4,020K (seasonally adjusted and annualized), bringing the total drawback since the beginning 2022 to 38.1%. This was also the lowest level of sales observed in 12 years. Contract closings sagged for both single family dwellings (-1.1%) and condos (-4.5%) The US Department of the Treasury estimates that it reached its statutory debt limit on 19 January. However, the department estimates it can use extraordinary measures to allow the government to meet its obligations through the middle of the year. In exchange for raising the limit, Congressional Republicans want to exact spending reductions from the White House, something the administration of US President Joe Biden has forcefully resisted. Though debt ceiling negotiations may become contentious, Senate Republican Leader Mitch McConnell said the United States will never default Fed Vice Chair Lael Brainard, one of the more dovish members of the Federal Open Market Committee, said on Thursday that policy will need to be sufficiently restrictive for some time, adding that time and resolve will be required to lower inflation to the Fed’s 2% target The Federal Reserve Bank of New York’s recession model, which relies on the spread between the 3- month Treasury bill yield and the yield on the 10-year note, implies a 47% chance of recession over the next 12 months, the highest probability since 1982 The major indexes ended mixed for the week as recession fears appeared to weigh on sentiment. The narrowly focused Dow Jones Industrial Average performed worst and gave back a portion of its strong rally in the first two weeks of the year, while the technology-heavy Nasdaq Composite recorded a modest gain. Relatedly, dampening inflation fears helped growth stocks outperform, as the prospect of lower interest rates increased the implicit value of future earnings. Markets were closed on Monday in observance of the Martin Luther King, Jr. holiday In terms of data release, the Leading Economic Index is out on Monday. The index dropped 1.0% during November, a decline which adds to the evidence that economic growth is poised for a slowdown. The drop was the ninth consecutive monthly decline, a trend that historically has been associated with the economy falling into a recession in the months following the downtrend. What’s more, the monthly declines have been getting larger and weakness across the components appears to be spreading The GDP print is out on Thursday. Real GDP growth likely remained on a positive path in the final quarter of 2022. The real GDP is expected to rise 2.8% on a quarterly annualized basis during that period, an assessment slightly ahead of the current Bloomberg consensus. While December’s sharper-than-anticipated fall in retail sales spurred us to revise down our estimate of personal consumption expenditures (PCE) growth, consumer spending still looks to have expanded solidly in Q4. Business investment is also shaping up for a sturdy gain, driven by upturns in equipment and intellectual property products investment. Structures investment is expected to turn positive for the first time in two years alongside an up-shift in new projects and easing material inflation. By contrast, a drop-off in housing activity will continue to drag down residential investment significantly. Public outlays look to be supportive of growth, with government purchases anticipated to rise modestly in Q4. Inventory building appears to have shifted slightly higher, adding to growth in the quarter 

Inflation figures for December have been released. The CPI was 0.4% MoM, 10.5% YoY, while core inflation was 0.5% MoM, 6.3% YoY, CPIH was 9.2%, down from 9.3% in November (October was the peak). The largest downward contribution to the change in both the CPIH and CPI in the past month came from transport (particularly petrol and diesel), clothing, and recreation and culture, with rising prices in restaurants and food making the largest and partially offsetting upward contributions. The less followed RPI was 0.6% MoM, 13.4% YoY, this still matters as a number of inflation adjusting contracts use RPI, as do index linked Gilts. The continued falling away in inflation figures from their October high is welcomed, and expected. There are reasons to remain cautious though: the global cost of energy has clearly plummeted and the base effect alone (measuring today’s prices against levels from a year ago) will naturally be taking inflation down in coming months. There are, however, two caveats. Firstly, energy prices remain highly volatile given that any settlement in the Ukrainian crisis is far. Secondly the Bank of England is particularly concerned about core inflation, stripping out volatile energy and seasonal food prices. Alongside these concerns, there are ongoing demands by a wide range of public sector Trades Unions for pay increases that match inflation, a factor that is likely to prompt the MPC to act ahead of inflation that much sooner and more decisively. 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 Bank of England (BoE) Governor Andrew Bailey said in a newspaper interview that a second consecutive month of slowing inflation could be “the beginning of a sign that a corner has been turned.” He also suggested that financial market expectations that rates would peak at 4.5% was not dissimilar to the bank’s view. “I am not endorsing 4.5%, but what you may have noticed in December is that we did not include the comment that we made in November about the market being rather out of line.” Financial markets were pricing in interest rates peaking at about 5% in November. Bailey also said he still expected a “long, but shallow” recession in the UK this year The UK’s GfK consumer confidence indicator fell to -45 in January 2023, down from -42 and well below market expectations of -40. The weaker-than-expected print has been driven by consumers’ declining assessment of their own personal financial situation and perceptions of the state of the economy over the past 12 months. This reading will come as a disappointment to policymakers given consumer confidence had been observing slow upward momentum since September 2022, when the reading reached its record low of -49 December’s retail sales figures also come in below market expectations. Retail sales by volume incl. auto fuel registered at -1% MoM and -5.8% YoY. Sales volumes are still below their pre-pandemic levels (1.7% under February 2020 levels). In December, non-food stores sales volumes saw a drop of 2.1% over the month, with retailers reporting that consumers are cutting back spending due to price and affordability concerns  

ECB President Christine Lagarde dismissed market speculation that a fall in energy prices would allow policymakers to slow the pace of monetary policy tightening. Speaking at the World Economic Forum in Davos, Switzerland, she said: “I would invite [financial markets] to revise their position; they would be well advised to do so.” She explained: “Inflation, by all accounts, however you look at it, is way too high. Our determination at the ECB is to bring it back to 2% in a timely manner, and we are taking all the measures that we have to take in order to do that.” The minutes of the ECB’s December meeting—when the Governing Council raised key rates by half a percentage point—also suggested that forthcoming rate hikes might be higher. The minutes showed that a “large number” of members wanted to raise borrowing costs by 0.75 percentage point. These policymakers only backed the smaller increase once the remaining central bank governors agreed to maintain a hawkish stance Shares in Europe weakened after European Central Bank (ECB) policymakers signaled that they would still hike interest rates aggressively, reigniting fears of a prolonged economic slowdown. In local currency terms, the pan-European STOXX Europe 600 Index ended the week modestly lower. Major stock indexes were generally softer. Germany’s DAX Index fell 0.35%, France’s CAC 40 Index eased 0.39%, and Italy’s FTSE MIB Index was almost flat   

The Chinese economy stagnated in Q4 as zero-COVID policies continued to curtail activity. Indeed, real GDP remained flat on a quarterly basis after expanding 3.9% annualized in Q3. YoY, it grew only 2.9%, but this was still significantly above the median economist forecast of 1.6%. Full-year GDP growth came in at 3.0%. Other than in 2020, when GDP expanded just 2.2% as a result of the pandemic, this was the weakest growth figure registered since 1976. After a difficult start caused by a huge wave of COVID-19 infections following the abandonment of health restrictions, the Chinese economy should rebound strongly in 2023, supported by elevated household savings. The housing sector, meanwhile, should benefit from recently unveiled support programs aimed at indebted property developers. However, risks remain, including those associated with lower foreign demand amid a global economic slowdown The value added by China’s property sector to the overall economy slumped 5.1% in 2022 from the prior year, according to data from the National Bureau of Statistics. Other data showed that new home prices fell 1.5% in December from a year earlier, the eighth straight month of year-on-year declines. Analysts polled by Reuters forecast that property sales in China would decline in 2023 for the second straight year but to a smaller extent compared with 2022 amid an expected recovery in economic activity later this year Chinese equities rallied for a fourth consecutive week ahead of a weeklong holiday following reports indicating better-than-expected economic growth. The Shanghai Composite Index rose 2.18%, and the blue-chip CSI 300 gained 2.63%. In Hong Kong, the benchmark Hang Seng Index added 1.41%, according to Reuters. China’s financial markets will be closed for the Lunar New Year break, which starts on January 21, and will reopen on Monday, January 30   
Sources: T. Rowe Price, MFS Investments, Wells Fargo, TD Economics, Handelsbanken Capital Markets, National Bank of Canada, M. Cassar Derjavets