Chief Economist Eugenio J. Alemán discusses current economic conditions.
Tariff concerns are not only affecting inflation expectations but also Americans’ consumption patterns. Americans went on a spending spree at the end of last year, probably trying to pull purchases ahead of potential tariffs while eating pulled pork and enjoying the winter weather at the same time during the month of January. All this information was conveniently packed and embedded in this morning’s release of the retail and food services sales report for January (see our Retail Sales indicator on page 6).
The report also added more noise to an already noisy winter season and is expected to keep markets and policymakers on high alert for every bit of information. Although the weakness in retail sales in January is concerning, it has all the signs of an intentional pullback after a strong holiday season affected by potential tariffs down the road rather than fundamental weakness in consumer demand.
The fact that department store sales as well as sales at food and drinking places bucked the trend while nonstore retailers’ sales (i.e., online sales) declined during the month is probably an indication that the consumer is still feeling good and should recover its mojo in the months to come. Still, tariffs will remain a concern.
Will the Fed overreact again?
This week’s inflation numbers, both the Consumer Price Index and the Producer Price Index, plus the recent uptick in long-term inflation expectations have the potential to change Federal Reserve officials’ view on the path for interest rates for the rest of the year. Markets have moved fast – before the release of this week’s data, they expected almost two rate cuts before the end of the year to now just one rate cut in the middle of the year. If we add the threat of tariffs potentially adding more upward pressure on prices, then the change in expectations for rate cuts during the rest of the year may be justified.
But this week’s inflation numbers, while concerning, showed some slivers of hope. The first one has to do with shelter costs, which have a weight of about 35% in the calculation of the CPI measure. On a year-over-year basis, shelter costs slowed down further, from 4.6% in December of last year to 4.4% during January. It is true that other prices have picked up again but, as we wrote in the indicator on page 4, some of these increases may be overstating the true increase in inflation during the month.
Furthermore, some of the increases during the month are probably related to what economists call “residual seasonality,” which is expected to disappear over time. This is similar to what happened last year and spooked Fed officials into changing their view regarding the path of monetary policy for the year.
However, after the stronger than expected inflation numbers during the first quarter of 2024 due to one-off factors, inflation continued its disinflationary path during the rest of the year and Fed officials were pushed to accelerate their interest rate lowering campaign, penciling in a 50 basis points decline after the September FOMC meeting. The large decline in the federal funds rate was labeled a “recalibration” but was more a realization that they had overreacted to this residual seasonality.
Hopefully, they will refrain from making the same mistake this year. However, we are not completely out of the woods yet because, on top of the worry about residual seasonality, we have several additional factors that could add to policymakers’ worries this year. These factors are the potential for tariffs as well as the recent upward move in longer-term inflation expectations, which will keep Fed officials on guard.
The new administration has a big role to play if it wants the Fed to continue to lower interest rates during the rest of the year, as inflation expectations have been moving up lately due to fears of increases in prices due to the threat of tariffs. Cooler heads as well as some reassurances that these are being used as negotiating tactics will go a long way toward keeping inflation expectations anchored.
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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.
Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.
The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.
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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.
Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.
US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the
U.S. dollar gains "strength" when compared to other currencies.
Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).
ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.
Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households.
Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.
Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.
The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.
Conference Board Coincident Economic Index: The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing.
Conference Board Lagging Economic Index: The Composite Index of Lagging Indicators is an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.
New Export Index: The PMI New export orders index allows us to track international demand for a country's goods and services on a timely, monthly, basis.
Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated.
The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.
Source: FactSet, data as of 12/6/2024
