What the Data Has to Say About the Economy, Inflation and the Fed

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The S&P 500 flirted with bear territory to close out the week, as disappointing earnings from some bellwether retailers and hawkish comments from Federal Reserve Chairman Jerome Powell kept the spotlight on three of Wall Street’s biggest concerns: the path of inflation, economic growth and how aggressively the Fed may need to tighten rates.

Big-box retailers Walmart and Target highlighted inflation when announcing results that fell short of expectations, and Amazon earlier in the earnings season noted inflation as well as excess staff hired to meet a surge in demand during the height of the COVID-19 pandemic as headwinds in its earnings call. In addition, these results further support our belief that the long-awaited shift in spending from goods to the service sector is underway — a prime reason we think the current heightened level of goods inflation is set to ebb in the coming months and provide downward pressure on overall inflation. Meanwhile, Federal Reserve Chairman Jerome Powell continues to telegraph the Fed’s willingness to aggressively raise rates in its battle to rein in inflation. Markets initially shot up on Tuesday in response to Powell’s statements, only to fall sharply on Wednesday based on comments from the giant retailers.

But recent data, including more out this week, continue to give us comfort that the economy has room for additional moderate growth and that inflation will soften in the months and quarters ahead. Here’s some of the recent key data we’re watching that continues to support our belief.

Wall Street wrap

While most eyes were on retail earnings this week, it’s important to consider all the week’s data.

Leading economic indicators: According to analysis by the Conference Board, its latest Leading Economic Index survey continues to point to 2.3 percent year-over-year growth for 2022. While the Index’s latest reading edged down by 0.3 percent to 119.2, the survey remains up 1.9 percent over the six-month period beginning in October 2021, well above the -4 percent level the Conference Board notes indicate a heightened recession risk. Much of the decrease this month came from a deterioration in consumer sentiment. While the Conference Board believes the survey still points to economic growth in the near term, it admits that risks to the outlook are rising.

Housing market taking a breather. Mortgage applications fell 11 percent from the previous week, according to the Mortgage Bankers Association’s weekly survey, which dovetails with a sentiment survey out by the National Association of Home Builders that shows that builder sentiment has fallen to 69 — down from its 84 reading at the end of 2021 and well off its record of 90 in late 2020. Similarly, a drop in building permits was highlighted in the LEI.

Rising interest costs are taking a toll on affordability and having a cooling effect on housing demand. The slowing market should alleviate the supply deficit and result in slower growth for home prices, which will filter through inflation data in the coming quarters.

Vehicle inventories. The latest industrial production report for the month of April shows manufacturers’ vehicles rolled off the assembly line at a pace of 10.3 million units per year, the highest rate since March 2021. While the rate remains short of the 10.7 million annual clip of 2019, it is still a significant sign of improvement in supply. As production continues to ramp up, price increases should begin to slow.

We’ve already seen an improvement in vehicle prices in the latest Personal Consumption Expenditure report. The latest release shows vehicle and parts prices were up 19.6 percent year over year, but that is down from the 23.6 percent year-over-year increase reported in January. Contrast that against the 25-year period ending in 2019, when prices rose just 5 percent cumulatively during the entire period. This is a vivid example of many of the oddities we’ve been seeing in data and that we think will be resolved in the coming months, leading to lower inflation.

National financial conditions. Financial conditions continue to tighten, according to the latest National Financial Conditions Index from the Federal Reserve Bank of Chicago. Keep in mind, the Fed has increased its rate only 0.75 percent since the current hiking cycle began. Yet financial conditions have tightened significantly in anticipation of aggressive hikes going forward. The current reading continues a trend of steep tightening that began in October 2021. Jerome Powell has noted that financial conditions are what the Fed is broadly targeting when it implements rate hikes. The sensitivity that financial conditions have shown to the current 75 basis points in tightening could provide a path for more patience by the Federal Reserve Board. Should conditions continue their current trend, we believe the Fed will have room to undershoot expectations for additional hikes.

The week ahead

Here’s some of the data we’ll be keeping an eye on in the week ahead.

Tuesday: We’ll get an early peek at the health of manufacturing and services around the world when S&P Global releases its flash reports for May before the opening bell. We’ll be looking for any significant changes in overall trend.

Wednesday: Data on durable goods orders will start the day and could provide insights into whether consumers are continuing to redirect their spending away from big-ticket items.

Thursday: U.S. initial jobless claims will be reported in the morning. The labor market remains tight but has shown some signs of softening modestly. A lack of available help has created wage pressures, and any signs of slack could ease some of the burden for employers.

Friday: All eyes will be on the latest inflation figures as the latest Personal Consumption Expenditure report comes out from the U.S. Bureau of Economic Analysis.

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