Inflation’s Stubborn Streak

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

Bulls and bears alike found signs that bolstered their respective economic views in data out over the past week. However, a deeper dive into the latest readings of inflation, housing and employment continues to support our view that the economy is churning forward and the Fed’s focus on controlling what it can control could give it the ability to take a lighter touch than Wall Street expects.  

While markets rallied Friday, they were down overall for the week. Let’s dive into some of the key data we’re watching. 

Wall Street wrap  

CPI still high, but falling: The latest Consumer Price Index headline came in at 8.3 percent, below the 8.5 percent March year-over-year reading but still above Wall Street estimates. Month-over-month readings were also high, especially core inflation (minus food and energy). But it’s worth noting the core number came in hot because of a surge in the services component of inflation. Core goods prices rose a modest 0.2 percent and are now up 9.7 percent year over year, which is below last month’s 11.7 percent clip and February’s 12.3 percent. This is more evidence that consumers are shifting spending from goods to services.  

The fuel behind inflation’s rapid rise is quickly beginning to normalize. Trucking and shipping rates are moving back toward pre-pandemic levels. Inventories (outside of autos) are being restocked. And rising interest rates are likely to cool the red-hot housing market. While inflation levels are still high, it has likely peaked and should begin to normalize as we move through the year. 

Mortgage gains: Speaking of the housing market, mortgage applications increased 2 percent from the prior week, with loans for new purchases growing and refinancing activity easing modestly by 2 percent. Interest rates on new mortgages ended the week at 5.39 percent on a 30-year fixed loan. It was just last year that rates were as low as 3 percent. As monthly payments climb due to the higher rates, we believe appreciation of home prices will cool. Housing prices remain firm, but various markets across the country have shown signs of moderating. If interest rates continue to climb, we expect to see slower growth in the cost of buying a home.

Household balance sheets: Household debt loads are up somewhat, according to a new report from the Federal Reserve Bank of New York, with much of the increase tied to mortgages. However, consumers are paying down their expensive credit card debt, as credit card balances are down by $15 billion since the start of the year. Lower credit card balances should give consumers some cushion to absorb price increases.   

Steady employment: Initial jobless claims edged up slightly to 203,000, but the number of people collecting unemployment fell to 1.34 million, the lowest level since early 1970. Staffing challenges continue to add to inflationary pressures as businesses are forced to compete for employees. We will continue monitoring the labor picture in light of it being a component of inflation fueled by supply constraints.  

Optimistic outlook: Confidence among small business owners steadied itself, ending a three-month dip in optimism, according to the latest reading from the NFIB Small Business Optimism Index. Drilling into the survey, 70 percent of small business owners reported raising prices, which is down from the recent record of 72 percent set last month. However, in a sign that pricing pressure may ease materially in the near future, just 46 percent of those surveyed plan to raise prices in the next three months. 

Labor cost pressures are also showing signs of ebbing. A net 46 percent of respondents reported higher compensation costs, which is down from the recent high of 50 percent in January. Looking forward, just 27 percent of small business owners plan to raise wages three months from now (compared to a recent high of 32 percent in October 2021). Overall, the latest reading from the index came in at 93.2. Business owner confidence has a spillover effect on hiring plans and business investment. A generally optimistic tone is necessary to prevent temporary bumps in the economy from becoming an extended rough patch. 

The week ahead  

• Monday: The Empire State Manufacturing Index will provide a look at the health of manufacturing and general business conditions in the influential New York state region. The report can provide a glimpse of national trends businesses are facing. 

• Tuesday: Capacity utilization data and the latest retail sales numbers will both be released Tuesday morning. An improvement in utilization could provide welcome news on the inflation front. The latest retail sales data should yield insights into whether consumers are continuing to trend away from spending on goods. 

• Wednesday: New residential construction numbers for April will be released before the markets open. We’ll be watching the data for indications that higher mortgage rates are having an impact on demand for new homes. 

• Thursday: Existing housing sales figures will be released. As with the new construction report on Wednesday, we’ll be watching for signs that mortgage rates are having an impact on buyer behavior. 

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