Last week’s GDP report showed the economy grew at a 2.9% annualized pace in the fourth quarter, which puts 2022 full-year economic growth at 2.1%. Labor market strength remains a key support for the economy, as evidenced by historically low weekly jobless claims.
Importantly, inflation readings continue to fall, which should allow the Federal Reserve (Fed) to slow the pace of its interest-rate hikes. Falling inflation and a less-aggressive Fed, with a still-healthy labor market, increase the odds of a soft economic landing. 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.
Leading Indicators Continue to Signal Slowdown
The Conference Board’s Leading Economic Index (LEI) fell 1.0% in December, following a downwardly revised 1.1% drop in the month before. This was its 10th consecutive decline, with widespread weakness across indicators. Seven of the 10 LEI components made negative contributions at year-end, and the majority have deteriorated over the past six months.
The LEI is a predictive variable that is designed to anticipate (or “lead”) turning points in the business cycle by around 7 months. The 10 components of the LEI include: average weekly hours in manufacturing; average weekly initial claims for unemployment insurance; manufacturers’ new orders for consumer goods and materials; ISM Index of New Orders; manufacturers’ new orders for nondefense capital goods excluding aircraft orders; building permits for new private housing units; S&P 500 Index of Stock Prices; Leading Credit Index™; interest-rate spread (10-year Treasury bonds less federal funds rate); average consumer expectations for business conditions.
PCE Report Bolsters Lower Inflation Case
The Personal Consumption Expenditures (PCE) Price Index, a measure of the prices consumers pay for goods and services, is an important inflation metric that the Federal Reserve focuses on when setting monetary policy. Friday’s release of December data showed inflation pressures continued to recede. The PCE Price Index edged up 0.1%, the least in five months, largely due to lower energy prices. The core PCE Price Index, which excludes food and energy, rose 0.3%.
On a y/y basis, PCE prices posted 5.0%, down from 5.5% in the prior month and the lowest inflation rate since September 2021. Core PCE inflation eased to 4.4% from 4.7% in the prior month, the lowest rate since October 2021 and matching the consensus. The main contributor to the deceleration was goods inflation, particularly durables. Durable goods prices were up just 1.4% y/y, the least since February 2021 and a steep drop from the cycle peak of 10.6% y/y in early 2022. Services inflation, which is stickier, was unchanged from the prior month at 5.2% y/y. It has ticked down from its cycle peak of 5.5% y/y last October, but it is still near its highest level since 1985.
This report further strengthens the case for a downshift in Fed interest-rate hikes to 0.25% at this week’s Fed meeting.
Jobless Claims Show Labor Market Resiliency Continues
Initial claims for unemployment insurance dropped 6,000 last week to 186,000, its fourth consecutive decline. This was the lowest level of claims since April 2022 and only 20,000 above the cycle low of 166,000 reached last March.
Continuing claims in the previous week picked up 20,000 to 1.675 million, while the insured jobless rate edged up to 1.2%. While both indicators have moved up from their cycle troughs, they remain close to pre-pandemic levels and are low by historical standards. It suggests that workers who lose their jobs find new employment relatively quickly, another indication of strong labor demand.