The US and Euro Area Have Core Inflation Problems
Economic news and commentary for March 31, 2023
US Personal Income and Outlays
The US saw another solid month of income in February after a strong increase in January. Nominal personal income increased 0.3% MoM in February which lead to an increase of 0.2% MoM in disposable income. Real personal consumption expenditures increased 0.2% MoM nominally but fell -0.1% MoM on a real basis. This isn’t a huge surprise following the jump of 1.5% MoM in January. Consumption returned back to its trend of weak goods spending being offset by more solid services spending. Goods consumption was flat on the month as durable goods spending returned back to earth, down -1.5% MoM, after its 7.0% MoM surge in January. Nondurable goods spending continued at a solid pace of 0.9% MoM to offset that weakness. Services spending was just 0.2% MoM, the weakest it has been for some time, but it marks yet another month of an expansion in services consumption that has been a factor in buoying services prices. When looking at real measures of consumption, both goods and services spending were down -0.1% MoM, thanks to cooling inflation.
Oh yeah, inflation. Along with income and consumption data, we get an updated reading of the Fed’s favorite inflation index. The PCE price index grew 0.3% MoM and 5.0% YoY, which is a deceleration from the 5.3% YoY rate reported in January. Energy provided a negative impulse of -0.4% MoM to offset the 0.2% MoM increase in food prices and push that annual rate lower. The core PCE price index also grew at a pace of 0.3% MoM and also saw a deceleration in its annual rate, to 4.6% YoY from 4.7% YoY. Meager price increases in goods and services, each at 0.3% MoM, were not enough to overcome base effects which resulted in that tiny edge lower on core inflation. Undoubtedly, there has been some progress on inflation, but that progress had been happening at a very gradual pace. Since peaking at 5.2% YoY in October 2022, the deceleration in core inflation has never been more than -0.3 ppts in a month. At that pace, it would take another nine months to get the Fed’s inflation index to its 2% target. Even if we look at the annualized rate of the average of the last 3 months of monthly increases in the core PCE index (0.4% MoM), we get a rate of 4.9% YoY which is much too fast for the Fed. This creates a tricky situation since FOMC members will likely want to hike at least another 25 bps to tame this price growth even if the banking sector is proving to be unstable.
Euro Area Inflation
The first data on European inflation is coming in for March, and there is a similar story across many of the reports. The general euro area inflation index grew 0.9% MoM and 6.9% YoY in March, down from 8.5% YoY in February. This matched reports in France and Italy this morning headline inflation slowed -0.7 ppts to 5.6% YoY and -1.4 ppts to 7.7% YoY respectively. In all reports, energy deflation took center stage. In the euro area, the energy segment fell sharply, down -2.2% MoM, and the annual pace of energy price growth flipped to negative for the first time in years at -0.9% YoY. Similar movements occurred in France and Italy’s energy indexes in March as well. This is, however, where the inflation story stops being optimistic and gets a little darker. Food inflation remains a real problem as prices in the euro area increased substantially again, up 1.3% MoM, with no peak in sight yet. It is no coincidence that the absence of an apex has also come with an absence in a conclusion in the Russia-Ukraine war. Food prices weren’t the only hot component in the report as goods prices actually saw a higher monthly increase, up 2.4% MoM, and services prices posted another solid increase at 0.6% MoM. These monthly gains leave annual goods inflation above 6% YoY for the sixth month in a row and services inflation reaching a new peak of 5% YoY. In the end, the result is another advance in core inflation, up 1.2% MoM to 5.7% YoY (a 0.1 ppt increase over February).
With the deflation in energy largely expected, the development of food and core prices has been in focus. There are still many dynamic factors at play in deciding the path of the other three components which has made the task of forecasting inflation very tricky. Yes, supply chain constraints are largely behind us, but there are still lingering effects from a bumpy China reopening and a persistent war in Eastern Europe. Producer prices have come off the highs, but they are still at extreme levels compared to historical values. On top of that, it’s not clear that producers want to give up their pricing power so quickly since consumer spending has been relatively strong over the last year. Elevated wage growth adds to this problem since consumers are benefitting from higher incomes, and labor shortages have made it difficult for firms not to increase compensation. Today, we also found out that labor demand remained largely unchanged in February as the unemployment rate remained at a low 6.6% with another month of job gains. A new factor is coming into play, however, through the new financial instability in the banking sector which should strengthen the ECB’s cold shower of rate hikes on credit conditions.
Through it all, core inflation has remained largely sticky, much to the chagrin of Lagarde and other ECB leaders. The result in Europe will likely be another quarter of low growth instead of a contraction but that means that things are likely to be much more stormy down the road especially since the ECB might have to stomach a higher terminal policy rate to meet its inflation target.
Still to come…
9:45 am (EST) - US Chicago PMI
10:00 am - US UMich Consumer Sentiment
Morning Reading List
Other Data Releases Today
Japan's unemployment rate increased 0.2 ppts to 2.6% in February. Employment edged down -0.4% MoM while the total number of unemployed jumped 7.8% MoM or 13,000. Most of the increase in unemployment came in the 15-34 age group.
Japan industrial production improved 4.5% MoM in February but is still down -0.6% YoY. Shipments also increased at a strong pace, up 3.6% MoM. Forecasted results see production increasing 2.3% MoM in March and 4.4% MoM in April.
Japanese retail sales (value) grew 1.4% MoM and 6.6% YoY in February, up from 5.0% YoY in January. Wholesale sales increased 1.3% MoM and 2.3% YoY.
However, sales of goods fell -6.9% MoM, and sales of services fell -2.0% MoM.
China's CFLP Manufacturing PMI fell -0.7 ppts to 51.9 in March. The new orders and production indexes fell -2.1 pts to 54.6 and -0.5 pts to 53.6. On the other hand, the Non-Manufacturing PMI Business Activity index increased 1.9 pts to 58.2.
The UK Nationwide House Price Index fell -0.8% MoM and -3.1% YoY in March, down from -1.1% YoY in February. This is the largest annual decline since July 2009.
UK GDP growth in Q4 2022 was revised up from 0.0% QoQ initially to 0.1% QoQ.
The services sector grew 0.1% QoQ after an initial estimate of no growth, and production saw no growth, up from an estimate of -0.2% QoQ.
German retail sales (real) fell -1.3% MoM and -7.1% YoY in February. In nominal terms, sales fell -0.5% MoM but were up 2.6% YoY. Retail turnover in real terms is down -1.6% compared with February 2020.
German employment increased 0.1% MoM or 31,000 in February. The unemployment rate stands at 2.9% with the number of unemployed down -15,000 or -1.1% MoM.
French CPI grew 0.8% MoM and 5.6% YoY in March, down from 6.3% YoY in February. Component breakdown: food up 15.8% YoY (prev 14.8% YoY), energy up 4.9% YoY (prev 14.1% YoY), manufactured products up 4.8% YoY (prev 4.7%), and services up 2.9% YoY (prev 3.0% YoY).
The euro area unemployment rate was unchanged at 6.6% in February with the number of unemployed down -59,000 to 13.1 million. The euro area youth unemployment rate was unchanged at 14.4%. The number of unemployed youth is up 125,000 from a year ago.
Italy's CPI fell -0.3% MoM to 7.7% YoY in March, down from 9.1% YoY in February. Component breakdown: core inflation up 6.4% YoY (0.4% MoM), food up 12.9% YoY (0.9% MoM), energy up 10.8% YoY (-8.9% MoM), ex-energy goods up 5.6% YoY (0.5% MoM), and services up 4.5% YoY (0.4% MoM).
Canada's GDP grew 0.5% MoM in January with the goods sector up 0.4% MoM and the services sector up 0.6% MoM. The manufacturing sector expanded 0.5% MoM on strong durable goods manufacturing. Advance data suggest GDP grew 0.3% MoM in February.
Europe Inflation
Eurozone inflation drops as expected but core continues to rise (ING) - Headline inflation fell from 8.5% in February to 6.9% in March, but core inflation ticked up to 5.7% in a sign that the fight against inflation is not over. For the European Central Bank, we expect two more 25bp hikes before a peak is reached.
Italian inflation continues to fall as energy costs subside (ING) - Headline inflation in Italy came in at 7.7% in March, down from 9.1% in February. The disinflationary process is still in place and is mainly driven by the energy component.
German inflation drops but there’s no sign of broader downward trends (ING) - German headline inflation dropped in March to the lowest level since last summer. However, there are still no signs of any broader disinflationary trend outside energy and commodity prices.
France: Inflation falls, but not by much, and consumption drops (ING) - Inflation decreased in France in March, thanks to base effects on energy prices. Nevertheless, underlying inflationary pressures remain very high and food inflation will continue to rise. GDP growth will therefore likely remain weak, as confirmed by the falling consumer consumption in February.
US GDP Update
GDP Accounts Show Slippage in Corporate Profits in Q4-2022 (Wells Fargo) - The third estimate of real GDP growth in Q4-2022 showed the U.S. economy expanded at an annualized rate of 2.6%, little changed from the second estimate of 2.7% that was released a month ago..
US GDP (Q4 2022 — third estimate): GDP remains a poor indicator of economic durability (EY Parthenon) - US real GDP grew 2.6% annualized in Q4 according to the third estimate, down from the previous estimate of 2.7%. The latest revision largely traces back to downward revisions to exports and consumer spending. Imports were revised down as well.
Real GDP Growth in Q4 Was Revised Slightly Lower to a 2.6% Annual Rate (First Trust Portfolios) - Hold off on GDP itself for a moment. The most important part of this morning’s report was on economy-wide corporate profits, which declined 2.0% in the fourth quarter compared to the third quarter. However, the decline in profits was led by losses from the Federal Reserve, not the private sector.
US
U.S. Business Investment: Headwinds & Tailwinds (TD Bank) - As businesses get hit with a combination of higher costs, declining profits, higher interest rates, and tighter credit conditions, private nonresidential business investment is expected to slow.
What Has Driven the Labor Force Participation Gap since February 2020? (Liberty Street Economics, NY Fed) - The U.S. labor force participation rate (LFPR) currently stands at 62.5 percent, 0.8 percentage point below its level in February 2020. This “participation gap” translates into 2.1 million workers out of the labor force. In this post, we evaluate three potential drivers of the gap: First, population aging from the baby boomers reaching retirement age puts downward pressure on participation. Second, the share of individuals of retirement age that are actually retired has risen since the onset of the COVID-19 pandemic. Finally, long COVID and disability more generally may induce more people to leave the labor force. We find that nearly all of the participation gap can be explained by population aging, which caused a significant rise in the number of retirements. Higher retirement rates compared to pre-COVID have had only a modest effect, while disability has virtually no effect.
Construction Self-Employment Rises Post Pandemic (NAHB) - According to the 2021 American Community Survey (ACS), 23% (or close to 2.5 million) of workers employed in construction are self-employed. This is a whole percentage point higher than the share of self employed in construction in 2019, before the pandemic rattled the labor market. Even though the Covid-19 pandemic boosted self-employment across all industries, construction self-employment rates remain significantly higher than an economy-wide average of 10% of the employed labor force.
Distribution of 1-4 Unit Residential Construction Loans Among Banks by Asset Size (NAHB) - According to NAHB analysis of Federal Deposit Insurance Corporation (FDIC) data, large banks (assets greater than $10 billion) have increased their share of the residential construction loan market above pre-Great Recession levels in recent years. A 1-4 family residential construction loan is used for residential 1-4 family construction and land development. The majority of 1-4 residential construction loans are still held by small banks with less than $10 billion in assets, but their combined share of the residential construction market has decreased from 2014 highs.
Europe
Lending squeeze, rather than credit crunch (DWS Group) - For a change, Europe’s banking sector appears in reasonably good shape. That’s good news, not least as supranational decision-making remains fragmented.
Asia Pacific
Japanese recovery continues, but weakening labour data is a concern (ING) - According to various data released today, the Japanese economy is doing better than in the previous quarter. Industrial production and retail sales have rebounded solidly but labour market data softened somewhat in February. Therefore, the Bank of Japan will take cautious steps towards policy normalisation.
How Asia Can Ease Scarring from Lower Investment, Employment and Productivity (IMF) - Asia should prioritize reforms that address the investment scarring from high corporate debt, mitigate education losses, and boost digitalization.
Will the RBA pause or cut and what it means to investors and traders (Saxo Bank) - The plot thickens, for Australia’s central bank to pause rate hikes, with the market also expecting almost 20 bps of rate cuts in 2023. This is because inflation cooled more than expected, while Australia’s households, the second most indebted in the world behind Sweden, are showing signs of financial stress after the RBA’s 10 rapid rate hikes. Big banks are allocating capital for bad and doubtful debts, and the RBA themselves noted insolvencies and bankruptcies have risen, yet the ‘full effect’ of its interest rate rises have yet to be seen. Business surveys are pointing to weaker conditions and spending ahead, while 1 million mortgages are deemed ‘at risk’.
Canada
Small Business Optimism Continued to Improve in March (TD Bank) - The CFIB Small Business Barometer rose for a fourth straight month as confidence about the next 12-months improved by 3.5 points to 55.3 in March. The short-term outlook based on a 3-month ahead index also notched up by 3 points to 52.2. Following a few months of gains, both indexes are now at levels seen at the end of last summer.
Israel
Opposition to Israeli government’s proposed judicial changes (S&P Global) - Prime Minister Binyamin Netanyahu on March 27 announced his decision to "delay" (not "suspend", he emphasized) the second and third readings of a judge appointment committee bill, "to avoid deepening domestic rifts" and to conduct dialogue in the aim of reaching broader agreement with the opposition.
Inflation
Global | Inflation and Bottlenecks. February 2023 (BBVA) - Headline inflationary pressures have tended to ease, except in certain Latam countries, but core inflation is stickier. Supply disruptions have diminished in the US but not yet normalised to pre-pandemic levels in the Euro Area.
Firm Price-Setting Behavior Amid Elevated Price Growth: Evidence From Our Surveys (Richmond Fed) - Every month, the Richmond Fed surveys firms across the Fifth District to understand how economic and business conditions are changing. As a part of this survey, we ask firms to report the 12-month percentage change in the prices they receive from customers for their goods or services. Additionally, we ask firms to provide their expectations for how prices will change over the next 12 months.
FX
FX Daily: EUR/USD zeroing in on 1.10 (ING) - We think EUR/USD may break 1.10 next week before the US payrolls, as the dollar remains vulnerable despite some repricing of dovish Fed expectations, and confirmation that core inflation remains sticky in the eurozone today should endorse ECB hawkishness. If that's the case, Cable should follow with a break above 1.25.
Outlook
Worldwide PMI, US NFP and central bank meetings in focus (S&P Global) - The turn of the month brings about a new set of worldwide PMI data ahead of the US labour market report on Friday. Meanwhile central bank meetings will be held in various APAC economies including Australia, New Zealand and India, although the focus will be on comments from Fed speakers in the week for further insights after the March FOMC meeting. German output data and Japan's Tankan survey figures will also be due in a busy week of economic releases, in addition to several CPI figures.
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