The Latest Data Suggests an End to Rate Hikes May Be in Sight

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

Equity markets moved higher last week despite some selling pressures on Friday due to growing fears the economy may slip into recession in the coming months. Regular readers of our weekly commentaries will know that we consistently advocate that investors view the steady stream of economic data out each week in the context of how it fits together and to evaluate it in light of whether it is consistent with current trends, suggests a change in direction or may simply represent a one-off anomaly.  

Taken as a whole, the data out last week offered more evidence that the disinflationary process (the slowing of price growth) is gaining momentum, while the economy continues to show signs of cooling. Perhaps nowhere was the trend more evident than in the latest Consumer Price Index (CPI) report. 

The latest release shows that headline inflation grew at just 0.1 percent in March; prices rose 5 percent on a year-over-year basis, marking the slowest 12-month increase since May 2021. The readings reflect a decline from February’s monthly gain of 0.4 percent and year-over-year reading of 6 percent. It’s worth noting that, once again, shelter was the driving force of the increase in headline readings, with shelter costs up 0.6 percent for the month and 8.2 percent on a year-over-year basis. While still elevated, March’s shelter reading marked the smallest monthly increase since November 2022. As a reminder, shelter has a large and lagging effect on inflation readings in services (shelter accounts for 33 percent of the total CPI measure and has around a 12-month lag). All-in CPI when excluding the lagging shelter component was down 0.2 percent month over month on a seasonally adjusted basis and is now up just 0.5 percent in total over the past nine months (0.67 percent on an annualized basis).  

While the headline readings show continued progress in the fight against inflation, some in the financial press called out the core CPI reading as a sign that inflation remained too hot. Here again, we believe it is more valuable to evaluate the data in relation to prior reports as well as economic readings beyond CPI. The latest release shows that core CPI, which excludes volatile gas and food prices, rose 0.4 percent month over month in March and 5.6 percent year over year. While still elevated, it’s important to note that the latest year-over-year reading ties January as marking the slowest 12-month increase since December 2021. Importantly, the rate of price increases for services cooled to 0.4 percent for the month, down from February’s reading of 0.6 percent. Services inflation is now up 7.1 percent over the past year, down from February’s year-over-year reading of 7.3 percent. However, as with the headline reading, the core number looks far different when the lagging shelter category is removed. Core CPI excluding shelter over the past six months is up just 1.8 percent on an annualized basis and over the past nine months is up 2.7 percent on an annualized basis. The steady decline is noteworthy, as services inflation figures have been cited as a sticking point in the battle to bring down price pressures as consumer demand has transitioned during the past year from goods to services. 

The latest CPI report, as well as other data released last week, reaffirms our belief that the Fed has room to pause its rate hiking cycle and has room to cut rates later this year should the economy contract faster than what the current consensus estimates is a mild downturn. While members of the Federal Open Market Committee may still feel compelled to raise rates an additional 25 basis points during its May meeting, we believe barring any surprises, the move would likely mark a final increase before the committee pauses the current rate hiking cycle. This belief is reinforced by the minutes from March’s Fed meeting, which included an assessment by Fed staff that a recession is likely to occur later this year. 

Wall Street Wrap 

While CPI captured the lion’s share of attention last week, additional reports suggest that the trend of easing inflation and a slowing economy will continue in the coming months.   

Input costs edge lower: Producer input final demand costs declined 0.5 percent in March, according to the latest Producer Price Index (PPI) from the Bureau of Labor Statistics. Final demand goods prices dropped 1 percent, while services costs were down 0.3 percent. Core PPI, which excludes volatile food and energy readings, was up 0.1 percent month over month. On a year-over-year basis, core PPI came in at 3.6 percent, down 0.9 percentage points from February’s reading of 4.5 percent. The latest number continues what has been a downward trend that began following the March 2022 red-hot increase of 1.6 percent. Month-over-month readings have declined in three of the past four months, with January being the lone exception. Year-over-year unadjusted readings have logged steady declines from a March 2022 reading of 11.7 percent to just 2.7 percent in the latest report. 

The index measures price increases for finished goods leaving the factory. Given that, it is generally a forward-looking measure of where prices for consumers are headed. As the costs producers face for finished goods continue to ease, we expect to see further price relief for consumers at the retail level. 

Jobless claims rise: Weekly jobless claims moved higher again last week with 239,000 new claims filed, up from the prior reading of 228,000. The four-week moving average of claims, which smooths out some of the weekly volatility of the measure, came in at 240,000, marking the second highest level since November 2021 (the March 25 four-week average was 242,000). Continuing claims (those people remaining on unemployment benefits) remain elevated at 1.810 million. While the figure is down from 1.823 million the prior week, it’s still well above the level of 1.289 million recorded in September 2022. We view the higher level of continuing claims as an early sign of softening in the labor market as it becomes more difficult for job seekers to land positions. 

Business inventories creep higher: U.S. business inventories were up 0.1 percent in February, according to a release from the U.S. Commerce Department this week. The latest reading comes on the heels of a decline of 0.6 percent in January. On a year-over-year basis, inventories are now up 11.6 percent from February 2022. Likewise, inventories-to-sales figures also increased, rising to 1.37, up from February 2022’s reading of 1.24. With inventories steady or inching higher, businesses are unlikely to see a resurgence of pricing power soon.  

Long-term inflation expectations remain anchored: The latest consumer sentiment survey released by the University of Michigan shows long-term inflation expectations remain well anchored, with respondents expecting inflation to come in at 2.9 percent annually in the next five to 10 years. The latest figure marks the fifth consecutive month of consumers expecting price increases to be below 3 percent in the intermediate term.   

Independent businesses less optimistic: The latest data from the National Federation of Independent Business shows optimism among small business owners slipped 0.8 percent in March to 90.1, marking a three-month low for the measure. The latest reading is the 15th consecutive monthly reading below the long-term historical average of 98. As optimism declined, so too did hiring expectations, which reached the lowest point since May 2020.   

The week ahead 

Monday: A week heavy on housing reports kicks off mid-morning with the Home Builders Index from the National Association of Home Builders. 

Tuesday: We will get March housing starts and building permits from the U.S. Census Bureau. This data, along with the Homebuilders Index released on Monday, will provide insights on whether consumers can expect greater housing inventory in the months ahead.  

Wednesday: The Federal Reserve will release data from its Beige Book. The book will provide recent anecdotal insights into the nation’s economy and will highlight emerging regional economic trends. 

Thursday: We’ll get a look at existing home sales mid-morning by the National Association of Realtors. This report, along with the new homes data released earlier in the week, should provide a clearer picture of whether the rapid cooling of the real estate market has stabilized.   

Initial and continuing jobless claims will be announced before the market opens. Initial filings dropped last week, and we will be watching for signs that the employment picture is weakening.  

Friday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for April. Activity for manufacturing continues to show weakness; however, the services side has shown signs of treading water. We will be watching for signs that growth on the services side has begun to wane. 

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