This Week's State Of The Economy - What Is Ahead? - 18 August 2023

By: Taro Chellaram /Wells Fargo Economics & Financial Report/Aug 23, 2023

This Week's State Of The Economy - What Is Ahead? - 18 August 2023

Last week, consumer and producer price indices showed inflation pressures continuing to gradually ease in July. Inflation's descent has occurred alongside a streak of stronger-than-expected economic data, and this week was no exception. Retail sales surprised to the upside in July, rising 0.7% over the month. Growth was fairly broad-based, with nine of the 13 retailer categories reporting increased sales (chart). Control group sales, which feeds into the Bureau of Economic Analysis' calculation of real personal consumption expenditures, rose an even stronger 1.0%. The outturn presents some upside risk to our 2.0% (annualized) call for real GDP in the third quarter; the Atlanta Fed's GDPNow model estimate for Q3 jumped nearly a full percentage point to 5.0% on the sales data.

The renewed strength in retail sales, if sustained, could lend some support to the factory sector in the coming months. Industrial production rose an above-consensus 1.0% in July, bolstered by a surge in utilities output and motor vehicle & parts manufacturing. While headline production came in better than expected, growth in manufacturing activity has been choppy this year—the overall level of manufacturing output stands just 0.2% above where it started 2023. Manufacturers remain broadly cautious of not overproducing and careful not to take on too much inventory in this tight credit environment.

Borrowing costs continue to rise. Freddie Mac's average 30-year fixed mortgage rate crested a 21-year high this week (see Credit Market Insights), driven in large part by the recent ascent in longer-dated Treasury yields (see Interest Rate Watch). Higher mortgage rates crimped the housing market for the better part of 2022. Still, home buying demand has found firmer footing this year, especially in the new home market where builders are offering price cuts, rate buy-downs and other incentives to move on their inventory. The trend improvement in new home sales has put some wind in the sails of residential construction (chart). Single-family building permits rose for the sixth straight month in July and are running at a 930,000-unit annual pace. Permits typically lead housing starts by one to two months, and the recent acceleration suggests that single-family home construction will continue to recover this year.

In short, activity data show the U.S. economy expanding at a solid rate. The underlying resilience has led many economists, us included, to upgrade their outlooks. The minutes from the July FOMC meeting rang with a similar tune, as the Committee noted "the economy had been showing considerable momentum." At the same time, the FOMC stressed that "inflation remained unacceptably high" and appeared resolute in holding its benchmark rate higher for longer to ensure price growth is sustainably brought down toward its 2% objective. The participants also cited upside risks to inflation that, if realized, would necessitate further policy tightening. The hawkish stance underpins our expectation that restrictive monetary policy, even in the face of strong activity, will tip the U.S. economy into a mild recession in early 2024.

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