Focused Investing: Economy & Markets Update
When I was a kid, my grandfather worked for the state water department. His main task was to make sure farmers and ranchers in his region were getting the water they needed and not polluting. In fulfilling his responsibilities, he would frequently drive the rivers and canals in his region making sure the spillways were operating efficiently and the farms and ranches were getting the required amount of water. In summers, my grandfather sometimes let me go with him on these trips. There were three constants on these trips, the first was I loved spending time with my grandfather, second the country we drove through was always beautiful, and third, even the smoothest route was always bumpy.
What Happened Last Week
We are witnessing a similar bumpy ride in the economy today. The bumps are coming on the inflation front with the two most recent consumer price index reports showing inflation is above expectations. February inflation was up 0.1% in the month and is now up 3.2% year-over-year, a slightly accelerated rate from the 3.1% year-over-year in January. Core inflation, which excludes the volatile food and energy components, smoothed out and decelerated from 3.9% in January to 3.8% in February. The most significant bumps in the road came from inflation at the wholesale level with the producer price index for February reporting above expectations. The headline PPI increased 0.6% - 0.3% more than expected - while the core PPI, again excludes food and energy, increased 0.3% compared to expectations of 0.2%. The readings above expectations were due to higher energy costs growing 3.6% or greater last month.
Retail sales added to the bumps but were below expectations this time as the headline number posted a rise of 0.6% month-over-month when expectations were looking for a rise of 0.7%. More importantly, excluding autos and fuel, retail sales were up a weak 0.2% compared to expectations of 0.4%. The weaker retail sales match the decline in consumer sentiment which dropped in early March from the levels of both January and February. This weakness is coming from consumers expectations of future economic conditions.
This Week
The biggest news this week is Wednesday’s announcement from the Federal Reserve about the direction of interest rates, will they cut, raise, or hold. Last week’s inflation data strongly suggests the Fed will hold rates unchanged, but the weakness in the other data points is fuel to the fire that the Fed needs a cut to keep the economy on a smooth path. Thursday the preliminary reports from S&P on the health of the manufacturing and services sectors will be released with expectations looking for slightly weaker activity in both sectors. If we do see a decline, they are likely to be small and, as ever, the devil will be in the details with a focus on the inflation data contained therein. Thursday we will also get a peek at the labor markets with first time unemployment claims, which are likely to show a slight increase to about 214,000.
Our Take
The inflation data does show a little acceleration from December, but this is not out of line with falling inflation. Bumpy data always happens. The crucial factors to look out for are the leading indicators of inflation to get a picture of where inflation and the economy are really headed. The Institute for Supply Management Manufacturing and Services Indexes showed that the prices paid decelerated in February from January. On top of this, in both the consumer price and producer price indexes, it was the rise in oil prices that pushed inflation above expectations. On the consumer side, shelter did have an effect, but overall shelter prices moderated in February compared to January, so the outlook for inflation should not be so worrisome, bumpiness should be expected as inflation comes down. Further, we expect to see additional moderation in consumer spending with credit card debt at about $1.05 trillion, consumers need to pay down this debt and improve their balance sheets. Economic growth will come down from 2023 levels, but we don’t believe the economy needs a cut in rates to keep it on a smooth path as both businesses and consumers are showing continuing resilience in this higher interest rate environment. Through the bumps we will continue to do what we do best: to serve our clients and search for good investments to ensure they have healthy portfolios.