Consumer Price Index (CPI) Roars Again!

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

The past couple of weeks saw a variety of reports offering mixed signals on the outlook for the economy. The last column talked about the tug of war among profits, growth and inflation and we saw this play out the past couple of weeks through stock market reactions.

The Consumer Price Index (CPI) report showed another acceleration in prices, and peak inflation was delayed yet again. Prices increased by 1.3% over the month, the largest in a year, and hit a 9.1% annual rate.  Although the last report did show another uptick in price growth, we will likely begin to see some deceleration in prices the rest of the year.   In other words, last month may have been the high point on the inflationary front. The core CPI, which strips out food and energy, declined to 5.9%.   It peaked at 6.4% back in March.  While still elevated, nationwide gasoline prices have declined by almost a dollar since the first week of June.   We are also seeing declines in diesel, peaking in the first quarter of this year.  This is an important development in the inflation picture because of the energy impact on the overall CPI. While the overall change in the CPI was 9.1%, gasoline increased a whopping 60% in one year.  A year ago, used car prices had increased 45% over the year.  In this last report, used car price increases slowed to 7.1%.   While the headline inflation rate continued to climb, bond markets have begun to price in a deceleration in price growth. The implied rate of inflation with five-year TIPS (Treasury Inflation Protected Securities) declined from a peak of 3.56% in March down to 2.56% in July.

Despite the significant headwinds faced by the consumer, spending continues.  The last retail sales report showed an increase for June of 1%, exceeding the consensus estimate of .9%.    This was a signal for growth, and the Dow finished the day with a gain of over 600 points.  Household finances are holding up even in the face of inflation.  Delinquency rates on credit cards and consumer loans have ticked up slightly since June but remain well below levels that existed in early 2020, and not even close to rates observed in the Great Recession.

Higher interest rates are doing what the Fed intended, and signs of slowing in the economy are emerging.  Both existing and new home sales have fallen to levels that are close to early 2020.   Building permits have receded from higher levels of late 2021 and early 2022.   Jobless claims have increased from a trough of 168,000 in early April of this year to 251,000.  Industrial production has shown a slight decline in activity, but levels remain higher than pre-Covid activity.   The last Markit PMI Composite measure showed a contraction in business activity.

There is a strong possibility that GDP growth will be negative for the 2^nd quarter.  This will make two consecutive quarters of negative GDP growth.   The debate has already started about whether this means we are in a recession.   The traditional definition of a recession is normally 2 consecutive quarters of negative GDP growth.  However, much of what we have observed over the past two years has been anything but normal.  Given the tight labor market and consumer spending that is quite resilient, I don’t expect the National Bureau of Economic Research to declare a recession over the first or second half of the year.  As we’ve stated in prior columns, next year is more uncertain.

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

There has been a big debate about whether the US economy is currently in a recession, or if one is just around the corner.  Last week’s monthly employment report put the “currently in a recession” argument to rest, at least for now.  The Labor Department reported that the nation’s economy added 372,000 jobs in June, far exceeding the consensus estimate of 275,000.   The unemployment rate remained flat at 3.6%.  As this column has mentioned previously, it will be very difficult to declare a recession with an unemployment rate under 4% and an economy that continues to produce above-average payroll gains.  A good month in a normal economy is the addition of about 150,000 jobs, and recent activity is far exceeding that level.  The economy could see back-to-back quarters of negative GDP growth (the traditional definition of a recession), given that consumer spending must decline from sky-high levels observed over the past two years.

Additionally, the BLS JOLTS report showed that the number of job openings remains strong.   Over 11 million job openings exist right now, and this is almost double the 6 million unemployed. Weekly unemployment claims have increased by almost 50,000 since bottoming out in April of this year. While claims have been inching upward, readings are at levels not consistent with the declaration of a recession.

Manufacturing payrolls increased by 29,000 last month, higher than the consensus estimate of 23,000.  The ISM Index continues to show expansion in the manufacturing sector, but at a slower rate.  The latest Index came in at 53 (a number higher than 50 shows expansion), but this was lower than expected. While the ISM Report on Business did offer some evidence that the economy is slowing, durable goods orders, an important indicator of manufacturing, showed continued growth and remained strong. Factory orders and durable goods excluding transportation came in more than double what was expected.  Non-defense capital goods excluding aircraft are at the highest levels observed.

Over the next several weeks, we are going to observe a tug of war between different camps. There will be the “inflation less than expected” camp. Any data that point to a deceleration in prices will likely be met by strong positive responses in the equity markets. Related to this group is the “slower growth expected” camp. Economic data showing slowing growth will be met with either positive or negative reactions.  A positive reaction will occur due to the Fed getting a green light to slow interest rate increases. But a negative reaction will occur if this slower growth begins to erode profits. We saw this with last Friday’s employment report.  Payrolls came in very strong, and the unemployment rate remained flat at 3.6%.   The Dow and S&P 500 both finished lower on the day. This was an example of “good news is bad news” effect.   Good economic news brought a “bad news” response in the equity markets.  The positive jobs report was additional data for the Fed to continue aggressive rate hikes.  So, we will likely see another 75 basis points increase at the next Fed meeting.

We get the BLS CPI report on Wednesday.  Of all the economic releases, CPI is now probably the most important, ranking higher than the monthly employment report.  For the past two reports, “past peak” inflation was the phrase used in anticipation of each report.  However, market watchers were disappointed with headline inflation showing strong gains. The consensus is for another hot number, with inflation increasing at a rate higher than last month.  The month-over-month change in the core (CPI minus food and energy) rate of inflation will be closely examined for signs of slowing price growth.  The headline number is important but look at the month-over-month core CPI. If that shows some moderation from the previous month, look for a positive equity response.

Louisville Metro payrolls are up about 21,000 from last year. In absolute numbers, this is among the best over the past 30 years.  For May employment and labor force levels, Louisville is now higher than the totals that existed in May 2019, prior to the Covid pandemic.

An examination of Louisville Metro job postings reveals significant developments since pre-Covid times. First, we see that job postings continue to remain strong.  Job postings for the past quarter are about 20,000 higher than the level that existed for the same quarter of 2019 (Lightcast job postings data).   From April 2022 to June 2022, there were approximately 63,000 job postings across the Louisville Metro region, compared to roughly 43,000 in 2019.  While the Louisville Metro labor force has increased, it is not large enough to absorb the strong level of job postings.  On advertised salaries (fewer data are available on advertised salaries than job postings), we see significant increases in salaries from 2019.   Clark and Floyd advertised salaries increased by 21.6% and 23.9% respectively.   This represents a $6,848 increase in Clark and a $7,424 increase in Floyd.   It is important to note that these data are not from official government statistics but are retrieved from actual job postings with advertised salaries.   BLS data also point to wage gains across the region.

Data sources:  FactSet, BLS CPI, BLS Metropolitan Employment, Lightcast, BLS Employment, BLS JOLTS, ISM Report on Business, Census Factory Orders, Census Advance Report on Durable Goods.

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

One of the big stories of the last recession and ongoing recovery has been the labor force. The Bureau of Labor Statistics (BLS) released the monthly report on state employment and unemployment last week, and the report indicated that Indiana’s labor force growth showed additional progress, increasing by another 16,000 in May. Indiana is now up by 25,000 compared to last year, same time. Kentucky saw a small increase in its labor force and is up about 32,000 from last year.

Indiana’s unemployment rate remained flat at 2.2%, significantly under the May national rate of 3.6%. Kentucky saw its lowest unemployment rate in the history of the series, reaching 3.8%, down from the April rate of 3.9%.

Indiana saw a noticeable uptick in payrolls. The report indicated that Indiana added another 9,000 jobs, and total payrolls in Indiana now exceed the level that existed in February 2020 by about 15,000. Kentucky saw its payrolls decline by 5,000, and its payrolls remain about 22,000 under the level that existed in February 2020.

Turning to Southern Indiana, employment is at the highest level for an April reading in the history of the series. Employment in the region normally peaks in July of each year, but if we compare April 2022 employment to previous April levels, it was at the highest level.  The labor force is at the level that existed in February 2020. However, for an April reading, Southern Indiana’s labor force reached an all-time high. This places the region’s unemployment rate at a staggering 1.8%.

For the Louisville Metro region, like Southern Indiana, job postings continue to remain high. Over the last 30 days, job postings exceeded the number that existed around the same time in 2019, pre-Covid. The number of unemployed, relative to the size of the labor force, is at an all-time low.

We should expect to see continued gains in the labor force of both states.  Labor force growth remains a key measure of the ongoing recovery. A portion of inflationary pressures can be attributed to supply chain challenges, and labor force growth will help alleviate some of these.

The past two weeks did see an increase in the number of “bad news” reports. A big headline was in the BLS CPI report.  The CPI reading came in above consensus estimates at an 8.6% annual rate.   The core rate, which strips out food and fuel, was at 6% and slightly above expectations. There was a violently negative reaction in the equity markets. The high CPI reading signaled that the Fed could increase rates by more than ½ a percent.   And indeed, the Fed responded with an increase of 75 basis points the following week. Unlike the negative reaction that occurred to the CPI release, the markets closed higher that day.

We can see the impact of high gas prices and overall inflation on consumer sentiment.  The latest consumer sentiment survey showed another decline.  There are only two other time periods when sentiment was lower: the early 1980s and the Great Recession. Consumer sentiment is low because inflation is at its highest in several decades. Inflation is not the only driver of consumer sentiment, but it is a major factor, particularly with the high levels.  The combination of steep declines in consumer sentiment, along with equity market declines, historically equates to the recessionary territory.

There were a couple of regional reports in manufacturing that came in much weaker than expected.  The Empire Manufacturing report and the Philadelphia Fed Index both came in under expectations and moved lower. These are only two measures of manufacturing activity but could be providing early indicators of an overall slowing of manufacturing activity. While we may see some slowing in manufacturing, simply due to a continued transition to normalization, I’m not expecting a contraction in growth. The last ISM Report on Business indicated that orders remain strong and growing, and customer inventories remain at low levels.

We saw a small increase in unemployment claims, but this is generally a very volatile series.  So, we will need additional data and consistently increasing claims to lend strength to the recession argument.  Another important indicator is consumer spending, a significant component of GDP.   If we continue to see steady declines in consumer spending, along with increases in unemployment claims, the chances of a recession increase.

Higher gasoline prices and elevated inflation will begin to eat into consumer discretionary spending.  While household balance sheets remain strong, compared to pre-pandemic, consumers can only take so much.   Sectors that rely on discretionary spending may begin to be pinched by higher gas prices.   The last retail sales report showed a .3% decline in retail sales, but this was not necessarily unexpected.    The pandemic saw gains in retail sales that were above trend, and a return to a level consistent with earned wages is inevitable.    A transition from goods to services spending should also continue.   The latest report did see a decline in furniture and home furnishings and electronics and appliance stores.   Foodservice and drinking places saw an increase.

The wealth destruction taking place in the stock market will also not help. Even with the double punch of inflation and stock market declines, we should escape a recession this year.  Job openings are about double the number of unemployed, and labor markets remain very tight.   Next year, however, as the impact of higher interest rates is transmitted throughout the economy (one of the first impacts is the housing sector), the chance of a mild recession has increased.  My optimistic (and hopeful) pathway is that inflation begins to cool later this year, leading to a slower movement in Fed hikes, and strong positive reactions in the equity markets.

Sources:  Bureau of Labor Statistics State Employment and Unemployment, Census Retail Sales, FactSet, Burning Glass, BLS CPI May 2022, ISM Report on Business