Latest Economic Reports Paint a Mixed Picture, but Has Anything Changed?

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

Stocks finished mixed for the week as a full slate of data failed to provide investors with clear direction on what is next for the Federal Reserve or the economy. Reports on inflation, unemployment and wages all included details that could be used to make a case for either a soft landing or serve as another source of concern for the Fed as it tries to eliminate the threat of a still strong job market causing the type of wage–price spiral that defined the stagflation era that ran from 1966 through 1982.

Core inflation readings at both the consumer and producer level indicated price pressures remain muted; however, details in the Consumer Price Index (CPI) showed that so-called super core inflation remains elevated, with an increase of 0.4 percent for August, up from the previous reading of 0.2 percent and now at 4.1 percent year over year. Likewise, the Producer Price Index showed core inflation for producers grew a modest 0.2 percent in August; however, previously dormant input costs on the goods side of the economy grew by 2 percent. We had expected the disinflationary process to play out as the economic distortions sparked by COVID faded and the business cycle returned to normal. However, we believe persistent wage pressures have become an obstacle to a continuation of easing price growth and could result in prices ticking higher if wage growth outpaces the rate of inflation in the coming months.

As we’ve noted in past commentaries, we believe monthly economic data is most valuable when viewed in the context of longer trends and how it fits with other indicators. On that front, we see little in the latest numbers to alter our view that the Fed will be unwilling to declare “mission accomplished” in its fight against inflation until the labor market softens and wage pressures move to a range of 3.5 percent or lower for a sustained period. As a result, we anticipate the Fed will hold rates steady at its meeting this week, but we believe it is unlikely to reduce them from the current levels until there is a significant easing of wage growth, which we believe (regrettably)is only likely to occur through a rise in the unemployment rate.

Unfortunately, leaving rates at the current restrictive level is likely to lead to a shallow and short-lived recession, in our view. Fortunately, with inflation falling as it has and with inflationary and wage expectations well anchored, the Fed should have room to reverse course as necessary should an economic downturn take hold.

Wall Street Wrap

Disinflation process shows signs of stalling: The latest CPI release showed headline inflation grew 0.6 percent in August, up from July’s reading of 0.2 percent and above Wall Street expectations. On a year-over-year basis, prices rose 3.7 percent, up from the prior reading of 3.2 percent. However, volatile gasoline prices accounted for the lion’s share of the increase, with the energy portion of the calculation showing a 5.6 percent increase for August. The pace of shelter inflation eased somewhat, with the latest monthly reading coming in at 0.3 percent, down from July’s level of 0.4 percent. On a year-over-year basis shelter was up 7.3 percent, a decrease of 0.4 percent from July’s reading. As a reminder, shelter has a large and lagging effect on inflation readings in services (it accounts for 34 percent of the total CPI measure and has around a 12-month lag). In recent months we’ve seen price increases for the category ease as year-ago highs roll off the year-over-year calculation.

Core CPI, which excludes volatile food and gas prices, rose 0.3 percent in August, up from July’s 0.2 percent. On a year-over-year basis, the core reading came in at 4.3 percent, down 0.4 percent from the level of 4.7 percent recorded in July. The latest year-over-year figure marks the slowest 12-month increase since September 2021.

Additionally, the Cleveland Federal Reserve’s inflation reading, called the 16 Percent Trimmed Mean CPI, which excludes abnormally high and low categories, points to a loss of momentum in the disinflation process. The latest reading shows prices up 0.29 percent in August, a modest increase from July’s reading of 0.22 percent. However, median trimmed CPI was up 0.33 percent compared to July’s uptick of 0.18 percent. While one month does not make a trend, the latest inflation readings suggest that achieving further progress in reducing price pressures may be difficult until wages begin to soften, which is unlikely to occur without a corresponding recession.

Small businesses’ optimism eases as wage and inflation concerns linger: The latest data from the National Federation of Independent Business (NFIB) shows optimism among small business owners moved lower in August to 91.3, down 0.6 points from July. The reading marks the 20th consecutive month of readings below the 49-year average of 98.

The downtick in optimism comes as inflation concerns moved higher, with 23 percent of respondents identifying cost pressures as their primary concern, up 2 percentage points from July. While concerns about cost pressures moved higher, it’s important to note that the latest figure is down from July 2022’s reading of 37. Quality of available labor was another top concern, with 24 percent of respondents singling it out as a top challenge. Sales expectations were also dismal, with a net negative 14 percent of respondents expecting an increase in inflation-adjusted sales. The outlook on real sales growth is at a historically low level and suggests an economy that may be losing steam.

As it relates to wage strength, a net 36 percent of those surveyed reported raising wages during the period, down 2 percent from July’s reading. However, 26 percent expect to raise wages in the next three months, a jump of five percentage points from July’s results. While the percentage of small businesses raising pay has eased over the past few months, the pace of the decline has been slow. Concerns about qualified labor and an uptick in the number of businesses planning to raise wages could signal that wage pressures will prove resilient absent a drop in demand.

As cost concerns have moved higher, businesses have tried to pass along costs to consumers, with 27 percent of respondents saying they raised prices during the survey period, up 2 points from July. Additionally, 30 percent of respondents expect to raise prices during the next three months—this marks the second highest level since November 2022. For further context, that figure was as low as 21 percent in April of this year.

Gas prices send retail sales higher: The latest retail sales numbers from the U.S. Census Bureau show overall retail sales in July were up 0.6 percent from August’s downwardly revised reading of 0.5 percent. The latest data shows retail sales are up 2.5 percent on a year-over-year basis. Much of the headline number was the result of rising fuel prices. Indeed, when volatile gas prices are excluded, retail sales were up a more modest 0.2 percent for the month. The rise in sales comes despite real wages falling during the month, according to a report out last week from the Bureau of Labor Statistics. While the sales numbers are not adjusted for inflation, the latest monthly reading indicates that consumers continue to spend despite their paychecks losing purchasing power. Whether this trend can continue is unclear. The Federal Reserve Bank of San Francisco believes that the excess savings that consumers stockpiled during COVID will run out this quarter. The depletion of savings along with the resumption of student loan payment requirements this month may lead to more conservative spending habits for millions of consumers.

Manufacturing production remains anemic: Industrial production rose 0.4 percent in August, according to the latest data from the Federal Reserve. Manufacturing, the largest component of industrial production, rose 0.1 percent, down from the prior month’s pace of 0.4 percent, offsetting June’s 0.4 percent decline. Manufacturing remains a source of weakness for the economy, with industrial production up a weak 0.25 percent year over year and manufacturing, which makes up the bulk of industrial production, down 0.6 percent on a year-over-year basis.

Consumer sentiment steady: Consumer sentiment came in at 67.7 in September, down modestly from August’s revised reading of 69.5, according to the latest consumer sentiment survey released by the University of Michigan. The survey also showed that inflation expectations remained anchored, with respondents expecting prices to rise 3.1 percent in the coming year, down from August’s final reading of 3.5 percent. The current reading marks the lowest level since March 2021. Long-term inflation expectations also remain well anchored, with the latest reading coming in at 2.7 percent. The latest long-term expectations reading marks only the second time in the last 26 months that expectations fell within a range of 2.9 to 3.1. Commenting on the release, Joanne Hsu, the director of the Surveys of Consumers and a research associate professor at the Institute for Social Research at the University of Michigan, said, “Throughout the survey, consumers have taken note of the stalling slowdown in inflation, but they do expect the slowdown to resume.” Readings over the past several months are in stark contrast to the 10.4 percent and 9.7 percent, respectively, for near-term and long-term expectations recorded in 1980. Similarly, despite current elevated wage growth, expectations of future gains remain muted, with respondents anticipating a median increase in household income of just 1.7 percent in the coming year. The latest figure is in stark contrast to the stagflation-era level of 6.5 percent recorded in June 1980. The gap between then and now shows consumers continue to view inflation as a diminishing problem and wage gains as an anomaly, which should make it easier for the Fed to cut rates as necessary to spur economic growth.

Jobless claims increase: Weekly jobless claims were 220,000, up 3,000 from last week’s upwardly revised figure. The four-week rolling average of new jobless claims came in at 224,500, down 5,000 from the previous week’s upwardly revised average. The latest four-week average marks the lowest level since late February of this year and indicates a still tight labor market. Continuing claims (those people remaining on unemployment benefits) fell to 1.688 million from the previous revised reading of 1.684 million.

The week ahead

Monday: A week heavy on housing reports kicks off mid-morning with the Home Builders Index from the National Association of Home Builders.

Tuesday: We will get August housing starts and building permits from the U.S. Census Bureau. This data, along with the Homebuilders Index released on Monday, will provide insights on whether consumers can expect greater housing inventory in the months ahead.

Wednesday: The focus for the day will be on the Federal Reserve as it releases its statement following its monthly meeting. We expect the Fed will hold rates steady, and we will be listening for indications of whether the Fed believes wage growth remains too strong for the Fed to achieve its target of 2 percent annual inflation.

Thursday: We’ll get a look at existing home sales mid-morning from the National Association of Realtors. This report, along with the new homes data released earlier in the week, should give a clearer picture of whether recent signs of stabilization in the real estate market have taken root.

The Conference Board’s latest Leading Economic Index survey will be a key release during the week. For months, these reports have suggested the U.S. economy may be on the cusp of a recession. We will be scrutinizing the data for any indications of a change in the pace of the slowdown.

Initial and continuing jobless claims will be announced before the market opens. Initial filings were down last week, and we will be watching to see whether last week’s decrease was a temporary blip or a sign of continued strength in the job market.

Friday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for September. Activity for manufacturing continues to show weakness, while some recent data has pointed to an uptick on the services side. We will be watching for signs to determine whether the recent acceleration of growth in services is a temporary surge or a resurgence of strength. We’ll also be looking at inventory levels and readings for new orders to gauge the path forward for both industries.

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