Latest Inflation Data Fails to Deliver Ah-ha Moment

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

Stocks sank during the holiday-shortened trading week despite a surge for the Dow and S&P 500 on Friday. The weak showing for the major indices came during a week that offered little clarity about the path ahead for inflation or the economy. The latest reading from the Personal Consumption Expenditures (PCE) index from the Bureau of Economic Analysis showed core inflation, which strips out volatile food and energy prices, rose 0.2 percent in April—in line with Wall Street estimates. On a year-over-year basis, core inflation was up 2.8 percent, slightly above consensus estimates.

The cost of goods rose 0.2 percent in April, up from March’s 0.1 percent increase. Services prices rose by 0.3 percent, down from March’s 0.4 percent pace. On a year-over-year basis, inflation for services came in at 3.9 percent, down from March’s revised reading of 4 percent. Goods prices are up 0.1 percent year over year, the same-sized increase as in the prior month.

While the latest PCE report was largely in line with expectations, it did little to change the narrative that the final path toward the Federal Reserve’s target of sustained 2 percent inflation will be slow; nor did other inflation measures we monitor, including the Dallas Federal Reserve’s Trimmed Mean PCE, which removes outliers that can distort traditional PCE readings. According to the latest data, the six-month annualized pace of inflation is 3.1 percent, up from March’s reading of 3 percent and still well above the Fed’s target of 2 percent. Additionally, 50.1 percent of the components used to measure inflation saw prices increasing faster than the Fed’s target inflation rate. For context, at the end of 2023, that level was in the low 40-percent range.

To be sure, given some stronger than expected readings for both PCE and the Consumer Price Index during the past few months, a mostly inline reading offered investors some relief; however, with the pace of disinflation languishing, we continue to see little incentive for the Federal Reserve to cut interest rates in the near term. Unfortunately, the longer rates remain elevated, the deeper they will work their way into the economy. Data is already showing that debt servicing costs are taking a greater chunk of consumers’ income at a time when delinquencies on mortgages and car loans are climbing. Should the Fed be forced to hold rates higher for longer as stubborn price pressures persist, it’s more likely the cumulative effects of higher rates will take hold and cause a slowdown in the economy.

Wall Street wrap

Consumer sentiment paints a mixed picture: The latest data from the Conference Board shows consumer confidence climbed to 102 in May from the previous month’s final reading of 97.5. The reading marks the first time in the past four months that confidence rose. The expectations index, which measures consumers’ short-term outlooks for income, the labor market, business conditions and other categories, increased 5.8 points to 74.6. Consumers’ views of current business conditions fell; however, a strong labor market bolstered the overall reading. As a part of the index, the Conference Board measures how easy or difficult respondents find it to land a job. In May, those saying it’s hard to get a job declined to 13.5 percent, down from 15.5 percent the prior month. Those who viewed jobs as plentiful also declined, coming in at 37.5 percent from April’s reading of 38.4. The gap between those who find it hard or easy to get a job is the labor differential, something we track closely due to our belief that the current employment picture may make it difficult for the Fed to reach its target of 2 percent inflation. May’s labor differential came in at 24, up from April’s revised reading of 22.9.

The uptick in sentiment came despite consumers citing food and grocery prices as a major concern and 12-month inflation expectations rising to 5.4 percent (up 0.1 percent from the prior month). Purchasing plans for homes were largely unchanged in May and at lows not seen since August 2012. The lack of enthusiasm for home buying may be a reflection of interest rate expectations. The portion of respondents who think interest rates will rise in the coming year grew to 56.2 percent, up from April’s reading of 55.2 percent.

Given that consumer spending has been a driving force in the economy during the post-COVID boom, it’s worth noting that expectations of a recession in the coming 12 months increased again, with more consumers believing an economic contraction was somewhat or very likely. Should this trend persist, it could weigh on future buying decisions and result in softer demand.

Beige Book suggests modest economic growth: The latest release of the Federal Reserve’s Beige Book, which provides real-time anecdotal assessments of business conditions across the country, showed that the pace of economy rose slightly from the prior reading in the majority of the 12 Federal Reserve Districts. Most districts reported slight to modest growth in activity, with two reporting no change. Retail sales growth remained sluggish, with consumers pulling back on discretionary spending. Shoppers also continue to be sensitive to higher prices. Home sales rose modestly, although there were reports that higher interest rates were acting as a drag on sales. Tourism and business travel accelerated; however, many contacts in the hospitality industry had mixed outlooks for the remainder of the summer.

Given the impact a tight labor market and elevated wage growth have on inflation, it’s noteworthy that eight districts reported negligible or only modest increases in payrolls, and most regions reported improvements in the pool of available workers and employee retention. Importantly, as it relates to above-normal wage growth, many districts said that the pace of wage growth was mostly moderate, and one district noted that employers’ bargaining power had improved.

Pertaining directly to inflation, most districts reported price growth, with most describing the pace of growth as modest—a slight improvement from last month. Once again, several sources in the districts noted profit margins continued to be squeezed as consumers pushed back against price increases. Should profit margins continue to face pressures, businesses may turn to cutting payrolls to protect further erosion of margins.

Existing home prices rise: The most recent S&P CoreLogic Case-Shiller Index shows that home prices nationally hit a new record in March, rising 0.3 percent on a seasonally adjusted basis from the prior month. March’s reading shows home prices are up on a year-over-year basis, rising 6.5 percent since March 2023, marking nine consecutive year-over-year gains. The March reading marks the sixth time in the past 12 months that the index has notched a new all-time high. The rise in prices comes despite interest rates on a 30-year fixed mortgage hovering above 7 percent. Recent comments by members of the Fed have pointed to a drop in shelter prices as a potential source of additional disinflation. If home prices continue to rise faster than inflation, it would give landlords greater ability to raise rents in the future. A combination of higher home prices and rents would be a blow to the Federal Reserve’s efforts to bring inflation sustainably down to 2 percent.  

Jobless claims dip: Weekly initial jobless claims were 219,000, 3,000 higher than last week’s upwardly revised level. The four-week rolling average of new jobless claims came in at 222,500, up 2,500 from the previous week’s average.

Continuing claims (those people remaining on unemployment benefits) stand at 1.791 million, up 4,000 from the previous week’s revised total. The four-week moving average for continuing claims came in at 1.786 million, up 5,750 from the previous week.

The week ahead

Monday: The manufacturing sector will be in focus as the Institute for Supply Management (ISM) releases its Purchasing Managers Manufacturing Index for May. Recent readings show inflation pressures for manufacturers have risen as activity in the sector has perked up. We will monitor it for signs of additional price pressures and the pace of growth in activity.  

Tuesday: The Bureau of Labor Statistics (BLS) will release its Job Openings and Labor Turnover Survey report for April. We’ll watch for whether the gap between job openings and job seekers is continuing to narrow, which would help ease wage pressure for businesses. We’ll also keep an eye on the so-called “quits” rate to see if workers are feeling confident in their ability to find different or better jobs.

Wednesday: The ISM releases its latest Purchasing Managers Services Index. While the services side of the economy has been remarkably resilient, the pace of growth has slowed. We’ll be looking to see if this trend continues or has gained momentum. Another point of focus will be the measure of prices paid.  

Thursday: Initial and continuing jobless claims, which rose last week, will be out before the market opens. We’ll continue to monitor this report for signs of changes in the strength of the employment picture.

Friday: The BLS will release the jobs report. We’ll be watching to see if the rise in the pace of job gains continued in May. Importantly, we will be monitoring the labor force participation rate and wage growth. A rise in labor force participation could help ease the current elevated wage pressures. However, if the participation rate holds steady or declines, wage pressures are more likely to persist.

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