This Week's State Of The Economy - What Is Ahead? - 17 May 2024

By: Taro Chellaram /Wells Fargo Economics & Financial Report/May 23, 2024

This Week's State Of The Economy - What Is Ahead? - 17 May 2024

There was no shortage of economic data this week, but little did much to change the macro landscape. We got a fresh report on producer and consumer prices for April, which showed a step in the right direction for inflation after a hot first quarter of price growth. Retail sales came in a touch soft, but we anticipate that was more monthly noise than the start of the end of consumer momentum. And April industrial production and housing starts data both showed sectors constrained by elevated rates. The economic data continue to be broadly consistent with an economy that is growing at a modest clip despite still-elevated price pressures and tighter policy.

The inflation data received increased attention as analysts try and pinpoint when and if the Fed will begin to ease policy later this year. The Producer Price Index (PPI) was a bit firm in April, rising 0.5% amid higher services prices, though it did come with slight downward revisions to prior month's data. In terms of consumer prices, both the headline and core (excluding food and energy) Consumer Price Index (CPI) rose 0.3% in April, which drove the year-ago rates lower to 3.4% and 3.6%, respectively (chart). The year-over-year Core CPI now sits at a three-year low. The composition of inflation was also more favorable last month amid an easing in “super core” (services excluding primary shelter) inflation. Even as the slowdown in services inflation remains painfully slow, it resumed in April with core services prices up 0.4%, matching the Q4-2023 pace.

This week's data suggest a more modest reading (~0.25%) from the Fed's preferred consumer inflation metric (the PCE deflator). On balance, we expect the April inflation data should help restore some confidence that price growth is continuing to moderate through the month-to-month noise. But we believe we'll need to see a string of solid inflation reports to help induce the first rate cut.

Inflation may be softening, but price growth compounds for households and the inflationary environment is one of many reasons to be skeptical about the sustainability of consumer spending. Retail sales came in flat in April and the control group measure, which excludes key components and feeds into the BEA's measure of goods spending in the GDP accounting, slid 0.3% (chart). But this weak outturn came after an unusually-strong spending environment in March, and while retail is our first indication of spending in a given month, it's less comprehensive in that it mostly covers goods spending, while it has rather been services consumption that has accounted for most of the growth lately. We are not reading too much into this weaker retail print.

While the consumer sector continues to hold on, the industrial sector can't find its legs. Industrial production also came in flat in April, but that was due to a weather-related pop in utilities. The three-tenths drop in manufacturing output is more telling of current conditions. Demand remains constrained amid elevated borrowing costs and tighter credit conditions, which we expect to keep manufacturing in its narrow range for some time. There's a similar dynamic happening in the residential housing market. While underlying demand isn't necessarily the problem here, elevated rates are discouraging builders from new construction and eroding affordability. Housing starts rose 5.7% in April, but that gain was due entirely to a spurt of new multifamily development, which is highly volatile on a month-to-month basis and remains set on a downward trend.

We still look for the first cut from the FOMC to come at its September meeting, though the timing of easing is highly dependent on the incoming data. Any additional bumps on the inflation road would likely push that timing back, absent a marked deterioration in the labor market. But if the Fed begins to gradually lower rates later this year, we expect that to be supportive of manufacturing activity and new home construction. We'll just have to wait and see how the data evolve.

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