Data Suggest Inflation Will Continue to Move Lower

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Is the economy softening or not? Some data over the past week, including parts of the latest read on retail sales and employment, showed signs of strength. But there was plenty to suggest that we’ll continue to see downward pressure on inflation — giving the Fed potential breathing room on future interest rate hikes.

While some worry that the slowing economy will dip us into a recession, indicators continue to suggest that if there is a recession, it will be short and mild. With inflation turning a corner and the markets likely already pricing in a shallow recession, chances are we already hit the market’s bottom in mid-June, and equities will continue a rocky and grinding advance from current levels.

With that, let’s dive into the data that we’re watching.

Wall Street wrap

Key economic reports this week point to a slowdown, flattening consumer spending and a housing market that is moderating, all of which are positive signs for future inflation.

Key indicators point to economic slowdown. Leading indicators of future economic growth continue to weaken. The Leading Economic Indicators (LEI) index out last Thursday declined for the fifth consecutive month in July, dropping by 0.4 percent to 116.6.

The year-over-year measure is at zero, which sits on the precipice of pointing to a future recession. However, an interesting development is that the diffusion index — which measures how many LEI components are rising — has been increasing over the past few months. This suggests that under the surface some strength is re-emerging. The next few months of data will likely help identify whether or not we are headed into a recession in the coming quarters. If we are, we believe it would be mild given the overall strength of the U.S. consumer.

Consumer spending stagnates. Supply and demand are starting to shake out positively. According to the U.S. Census Bureau, overall consumer spending was flat in July thanks to declining gas prices and a drop in auto sales. However, excluding gas and auto sales, consumer spending was actually up 0.7 percent. The fall in the national average price of gas from $5.01 on June 13 to $3.90 on August 20 has freed up consumers to spend cash elsewhere.

While this still-strong spending may sound like an inflationary concern, the data also continue to show an alleviation of the shortage of inventories that helped cause heightened goods inflation over the past year. Indeed, this data now points to declining future goods inflation. As evidence, look no further than major retailers like Target and Walmart, which are having to discount to reduce excess inventories.

The major area that remains in short supply on the retail side is autos. However, last week’s industrial production, which rose 0.6 percent and is up 3.9 percent year over year, showed that vehicle assemblies rose to 10.72 million on a seasonally adjusted annual rate basis, up from the low of 7.5 million in September 2021. What’s more, production is now back to where it was before COVID-related supply chain issues hit the industry.

The housing market moderates. New home construction continues to show signs of softening as the industry grapples with higher interest rates and home price affordability. In Monday’s National Association of Home Builders (NAHB) Housing Market Index (HMI), builder confidence in new construction home sales fell 6 points to 49 percent, the first time since May of 2020 that the reading came in below the key break-even measure of 50 percent. This was the eighth consecutive month the index declined. Waning builder confidence is an indication that builders expect further softening in the months ahead. We are even beginning to see some modest discounts on new construction homes, as 19 percent of builders reported using price reductions as a means of boosting sales and limiting cancellations.

On Tuesday, the U.S. Census Bureau issued its residential construction statistics for July. This report also indicates a slowdown in the sector. New construction housing starts were down 9.6 percent from June, while building permits were down 1.3 percent.

When it comes to existing-home sales, which make up most of the market, the National Association of Realtors indicated that sales fell 5.9 percent in July from the month prior and were down 20.2 percent year over year. Median existing-home sale prices also declined $10,000 in July to $403,800. Home prices have a large impact on services inflation, so as home price appreciation moderates, we anticipate seeing a positive impact in CPI down the road.

The week ahead

Here’s some of the data we’ll be keeping an eye on in the week ahead:

• Monday: The Chicago Federal Reserve national activity index comes out Monday. This will give us an in-depth look at how the overall economy performed in July. The number is expected to be negative — meaning below-trend growth in the U.S. economy — but not yet at recessionary levels.
• Tuesday: Mid-morning S&P Global will issue its Purchasing Manager Index (PMI) reports for the services and manufacturing sectors around the globe. Together, these reports will give us insight into how the economy is faring at home as well as what’s going on in Europe as Russia’s war in Ukraine rages on.
• Thursday: Before the opening bell, the Federal Reserve will issue its second estimate of second-quarter GDP. Thursday is also when the Kansas City Federal Reserve’s Jackson Hole Symposium, entitled “Reassessing Constraints on the Economy and Policy,” kicks off. The Symposium runs through August 27, and Federal Reserve Chairman Jerome Powell is set to speak on August 26 at 9 a.m. CT.
• Friday: Late in the week we’ll get a look at what the Personal Consumption Expenditures (PCE price deflator, the Fed’s preferred inflation measure, says about cost pressures as consumers continue the transition from purchasing goods to services.

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