Economic Update | On Final Approach for a Soft Landing?

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Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

The big data point over the past two weeks was the print on CPI (Consumer Price Index). The Bureau of Labor Statistics reported that the annual change in the CPI declined to 3.0% in June, down from the prior month of 4%.  The 3.0% was less than expected and equity markets finished higher on the day. The core rate, which is CPI less food and energy, also declined, from 5.3% in May to 4.8% in June. The “stickiness” of inflation, sometimes described by officials and economists, refers to this core rate. The core for June came in under the consensus estimate and declined ½% from May to June.  The month-over-month change was .2%, compared to .4% in the prior month. Even though the core rate had been declining since September 2022 when it peaked at 6.7%, this was the largest monthly drop since. The reason why this was a significant report is that the narrative for two additional interest rate changes this year changed almost instantaneously. Yields on 2-year and 10-year Treasuries dropped as soon as the report was released.  The CME Fed Watch Tool is pricing another hike in July, but the probabilities favor this to be the last hike.  Prior to the CPI release, two additional hikes were on the table. While two hikes are still possible for the rest of the year, that scenario is now unlikely. 

More evidence of disinflation came the next day with the release of the PPI (Producer Price Index).   The year-over-year change in the PPI was 2.4% in June, down from 2.6% in May.    Taking the monthly change of .1% in June and stretching this out over a year would produce a year-over-year change of 1.2%.      

The economy is not yet in a recession, and one is not likely in 2023. National manufacturing, however, continues to be in a slump.  The last employment report saw manufacturing gain only 7,000 jobs, higher than the previous decline of 3,000.  The ISM manufacturing measure declined to 46, from the previous month of 46.9;  under 50 shows a contraction in manufacturing, and above 50 shows expansion.  The number has been under 50 since October 2022.   Both new orders and the backlog of orders have been trending down all year.  Even though the overall index has been declining for almost a year now, it is not quite yet at a level that coincides with a recession. The lower 40s range is closer to recessionary territory. While national manufacturing is seeing a slowdown, we are not seeing the same in the Louisville Metro region.    Preliminary payroll data show that manufacturing payrolls are growing at a rate that exceeds overall payroll growth. One possible reason is the pent-up demand that we are seeing in automobile sales and the impact on area manufacturers. 

The national slowdown in manufacturing was anticipated due to the surge in goods spending experienced during the pandemic and the months following.  As the economy reopened and spending transitioned from goods to services, goods spending had to normalize. The services economy continues to grow, however.  The last ISM services index came in at 53.9, compared to 50.3 the prior month, and higher than the consensus estimate of 51. As inflation continues to moderate, consumer optimism will increase, providing further support to the service economy.  The latest Michigan consumer sentiment survey saw a big jump in optimism, with the index coming in at 72.6 compared to 64.4 in the prior month. To be sure, consumers are still in the doldrums when we compare current levels of sentiment to historical levels.  But the optimism is on the upswing.   The Conference Board consumer confidence measure is more favorable and has been trending upward since July 2022.

We’ve heard a lot about soft and hard landings over the past year. With indicators over the past couple of weeks, the narrative is going to move in the direction of a soft landing. We will see no recession for the remainder of 2023.  If we continue to see moderating prices, and I think that is the case, there will be no additional hikes past July. Disinflation will support consumer moods and  spending, and a tight labor market will serve as a buffer from a slower economy, which is still expected.  A soft landing may in fact be the best-case scenario of 2023 and into 2024.    

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