China’s sudden reopening, a mild European winter, and weaker dollar are positive catalysts for the global backdrop. However, Fed interest-rate hikes act with a long and variable lag and they are doing this while the economy is losing momentum. This has us remaining cautious on stocks and other risk assets.
Retail Sales and Industrial Production Fall
Retail sales dropped 1.1% in December, the most in a year, and slightly worse than the consensus of -1.0%. The previous month was revised down to -1.0% from -0.6% initially, resulting in the biggest two-month drop in retail sales since the lockdowns in April 2020. Some of the decline reflects falling goods prices, but it also shows some retrenchment in consumer demand.
The weakness was broad-based across retail categories, with several falling more than 1.0% from the previous month, including furniture, electronics, miscellaneous, and online sales. On a y/y trend basis, retail sales eased to 6.7%, the slowest pace since February 2021, although that is still stronger than pre-pandemic. While consumers may be spending more on services where there is still pent-up demand from the pandemic, the pullback in goods spending indicates that consumer demand is softening. It suggests the risk of recession in 2023 elevated.
Industrial production fell 0.7% in December, following a downwardly revised 0.6% drop in the prior month, and worse than the consensus of -0.1%. It fell at a 1.7% annualized rate in the fourth quarter, down for the first time since Q2 2020. Industrial production was still up 1.6% from a year ago, but that was the slowest y/y growth rate since March 2021.
The deterioration at year-end of both retail sales and industrial production adds to concerns that broad economic activity continues to lose momentum, keeping the risk of recession elevated.
Producer Prices Bolster Lower Inflation Case
The Producer Price Index (PPI) for final demand fell 0.5% in December, its first decrease in four months, and the most since April 2020. The consensus was for a smaller 0.1% fall. The biggest contributor to the decline was energy prices, which fell 7.9%, the second most in this cycle. Food prices fell 1.2%, the most in two years. PPI ex-energy and food ticked up 0.1%, the smallest gain since November 2020.
On a y/y basis, the PPI for final demand eased to 6.2%, the slowest pace since March 2021, while its core fell to 5.5%, the least since May 2021. Price pressures continued to ease across most stages of production, suggesting that PPI inflation for final demand should also continue to moderate. Along with slower consumer price inflation (CPI), this report strengthens the case for a downshift in Fed interest-rate hikes to 0.25% at the February Fed meeting.
Jobless Claims Show Labor Market Resiliency Continues
Initial claims for unemployment insurance dropped 15,000 last week to 190,000, its third consecutive decline. Claims matched their lowest level since April 2022 and are not that far from their cycle low of 166,000 reached last March. Continuing claims in the prior week edged up 17,000 to 1.647 million, while the insured jobless rate was unchanged at 1.1%. Similar to initial claims, both indicators are off their cycle troughs but remain close to their prerecession levels and are subdued by historical standards.
Despite an increasing number of company reports of layoffs and/or hiring freezes, the low level of initial and continuing jobless claims indicates that workers who lose their jobs find new employment quickly, as labor demand, in aggregate, remains strong. The resilience of the labor market pushes against a recession call at this time, even though data such as retail sales, industrial production, and recent business surveys, reflect significant weakening in economic activity.