Financial system instability overshadowed a week replete with economic data. U.S. policymakers’ swift reaction to the collapse of several regional banks initially calmed concerns of rising stress in the banking sector. However, a plunge in share prices of a global systemically important bank toward the end of the week shows that contagion fears remain highly elevated. For more insight on the state of the banking sector, please see the Topic of the Week. Recent events have led us to make a few adjustments to our monthly U.S. Economic Outlook, which we published on March 17.
Financial system strain presents the latest challenge for the Federal Reserve, which is still in the trenches in the battle against inflation. The Consumer Price Index (CPI) has been moderating on trend over the past several months. Additional signs of meaningful cooling were absent in February's CPI print, however. The headline CPI rose 0.4% during the month, just slightly slower than the 0.5% monthly rate registered in January. The increase in the headline index was in line with market expectations, but the monthly change in the core index, which excludes more volatile food and energy prices, was a bit hotter than anticipated. The core CPI increased 0.5% during the month and is now running at a 5.2% three-month annualized rate, well above the FOMC’s 2% inflation target.
On the other hand, producer prices declined during the same period, with an unexpected 0.1% fall in the Producer Price Index (PPI) during February. On a year-over-year basis, the headline final demand PPI moderated to 4.6%, down from 5.7% the month prior. Overall, the easing in the PPI is an encouraging sign that underlying inflation pressures are not intensifying. That noted, the stickiness in consumer price inflation indicates that the path back to the Fed's target is likely to be long and winding.
On balance, the rest of the economic data released this week demonstrated that the U.S. economy remains on a positive trajectory. Retail sales pulled back 0.4% in February. The drop was not a surprise, however. Sales rose a robust 3.2% in January and some payback was expected in February. Furthermore, control group retail sales rose 0.5% during the month. Control group sales are an input to personal consumption expenditures, a major subcomponent of GDP. All told, the solid gain in control group sales, as well as upward revisions to prior months' sales, paints a positive picture for real GDP growth in the first quarter of 2023.
An uptick in manufacturing production is another sign that economic growth is still holding its head above water. Total industrial production was essentially unchanged in February. Similar to retail sales, however, estimates for production during January were revised higher. Digging deeper, February's flat reading occurred as mining production fell 0.6%, utilities production rose 0.5% and manufacturing production edged up 0.1%. All that being said, February's report shows that, while still expanding, factory output is moderating alongside rising interest rates and slowing demand for goods.
Housing production is another area that has been hit hard by higher interest rates. Total housing starts jumped 9.8% to a 1.450 million-unit annual pace in February. The monthly gain in total starts was mainly owed to a surge in multifamily construction, however. Single-family starts inched up during the month but are still running almost 32% below the prior year's pace. Still, single-family permits rose for the first time in 12 months during February. The gain follows a recent improvement in the NAHB Housing Market Index, which increased for the third straight month during March. In addition to finding success with incentive programs, builder optimism has been boosted by sidelined buyers starting to return. Through March 10, mortgage applications for purchase have risen for two consecutive weeks, ending the declines seen throughout February. The turnaround in mortgage applications and jump in housing construction adds to the evidence that residential activity is starting to stabilize as buyers become more accustomed to a higher rate environment.
One economic indicator that has not improved this year is the Leading Economic Index (LEI). The LEI fell 0.3% during February, the 11th-straight drop. As we have often noted, the trend decline in the LEI is a clear warning sign that the economy is nearing an inflection point. One of the subcomponents of the LEI that has been a recent drag on the top-line index is consumer expectations, which appear to be dimming. The preliminary reading for consumer sentiment, as measured by the University of Michigan, fell to 63.4 in March from 67 the month prior. While both short- and long-term inflation expectations eased in the survey, sentiment surrounding current and future conditions declined. Overall, the economic data published this week show that the economy remains on a positive path, for now. Unfortunately, the current banking crisis will likely lead to even tighter credit conditions which lends credence to our view that the U.S. economy is headed for a recession in the second half of 2023.
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