Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
Equities closed higher last week as investors continued to focus on debt ceiling negotiations in Washington. Growing optimism during the last two trading days that a deal would be reached before the government ran out of funds to meet its obligations more than offset selling pressures earlier in the week stemming from a temporary standstill in negotiations.
Over the weekend, President Joe Biden and House Speaker Kevin McCarthy announced a deal had been reached that would suspend the debt limit for two years. We are encouraged by the announcement but won’t be surprised if a contentious debate now takes place in the House and Senate as representatives from both sides of the aisle comb through the details of the plan. However, we continue to believe that a solution will be agreed upon and the U.S. will avoid defaulting on its debt.
The promising developments out of Washington overshadowed the latest Personal Consumption Expenditures (PCE) index release, which showed a pause in the disinflationary process (a decline in the rate of inflation) but with price pressures still well below year-ago levels. The latest data from the Bureau of Economic Analysis shows headline prices were up 4.4 percent from April 2022, slightly higher than March’s reading of 4.2 percent. On a month-over-month basis, headline PCE was up 0.4 percent compared to a 0.1 percent increase for the prior month. Core PCE, which strips out volatile food and energy prices, was up 4.7 percent year-over-year and 0.4 percent from the prior month. Consensus expectations were for headline and core readings of 4.3 and 4.6, respectively. For comparison, core PCE was up 4.6 percent and 0.3 percent, respectively, on a year-over-year and month-over-month basis in March. The same report shows consumer spending rose 0.8 percent in the month, while income rose a more modest 0.4 percent, and the personal savings rate declined 0.4 percent. Put simply, consumers dipped into their personal savings to afford a surge in spending. Spending from savings is not sustainable, as most consumers have a limited cushion from which to draw.
As with the temporary jump in prices seen in January of this year, we believe it is too early to conclude whether the latest uptick in inflation marks a new phase or is yet another sign of the uneven economy and bumpy road in the disinflationary process. As such, we continue to believe investors should focus on the overall trend of the data. And on that front, we remain encouraged that inflation is receding. Consider that as recently as September 2022, headline inflation was at 6.3 percent year over year, while core PCE was running at 5.2 percent. Progress has been painfully slow at times, but we remain convinced that the trend points to further easing of price pressures in the months to come. As a reminder, goods inflation peaked at 10.6 percent year over year in June 2022 and is now running at 2.1 percent over the past 12 months. The services side of the economy was slower to recover from COVID, and as a result, inflation was slower to peak, finally hitting a high of 5.8 percent in February of this year. Since then, services prices inflation has edged down to 5.5 percent on a year-over-year basis.
Unfortunately, the latest data reopens the door for the Federal Reserve to raise rates at its upcoming meeting in mid-June. Until the latest PCE data came out, it was widely expected that the Fed would pause rate hikes and monitor the data as the previous 10 rate hikes continued to work their way through the economy. However, given the still-strong employment picture, the Federal Open Markets Committee may view the latest inflation data as cause to continue to raise rates. While this is a possibility, it is not yet a forgone conclusion, with the markets forecasting a 58 percent chance of a hike in mid-June. As the minutes of the Fed’s most recent meeting last week showed, there is a growing divergence among Fed members as to whether additional hikes are needed. Given that the Fed’s internal forecasters are predicting a recession in the second half of this year, it is still conceivable that the Fed may be willing to take a wait-and-see approach before continuing to ratchet rates higher. We believe that the latest inflation data makes this week’s employment numbers all the more important in the Fed’s decision-making process.
Wall Street Wrap
Last week’s economic data continued to point to an uneven economy, with some areas suggesting we are in or on the cusp of recession, while others remain resilient in the face of higher rates and tighter lending standards.
A tale of two economies: The latest data from the S&P Global Composite Purchasing Managers Index showed that the gap between the health of the manufacturing and services sides of the economy continues to grow.
The Composite Output Index reading came in at 54.5, up from April’s reading of 53.4. However, the latest numbers show that despite overall activity moving higher, manufacturing slipped back into contraction with a reading of 48.5 (readings below 50 indicate contraction). The level was down from April’s level of 50.2. The move into contraction resumes a streak of sub-50 readings that began in November 2022 and was uninterrupted until the April reading. Demand conditions fell significantly, with new orders coming in at the lowest level in three months. Increased prices charged by manufacturers along with well-stocked inventories among clients was blamed for the downturn in new orders. It’s important to note that respondents indicated they had an easier time finding workers to hire. While hiring reached its quickest pace since September 2022, the seemingly increased availability of workers may help keep wages in check. Additionally, costs for manufacturers declined as input cost pressures turned negative for the first time since May 2020.
While the manufacturing side of the economy remains mired in contraction, the services side showed solid strength with a reading of 55.1, up from the prior month’s level of 53.6. Output and new orders jumped in May; however, it’s important to note that much of the increase in new orders came from abroad. We view the growing divergence in strength between manufacturing and services as an indicator of the unevenness of the economy during the past several months.
New home sales rise as prices fall: New home sales rose to 683,000 units in April, according to the latest data from the U.S. Census Bureau. The latest figure is up 4.1 percent from March’s revised total of 656,000. On a year-over-year basis, new home sales are up 15.1 percent from the April 2022 figure. These numbers are volatile and are up from April 2022 levels but well below the pace of 830,000 units recorded at the end of 2021. Despite the uptick in units sold, the median price of a new home fell to $420,800, which represents an 8.2 percent decline from year-ago levels and a 15 percent drop from the October 2022 high of $496,800. While new homes represent a small fraction of total home sales, the portion has grown of late as owners of existing properties have been hesitant to sell given that interest rates have risen and moving may result in higher interest payments on new mortgages. The recent increase in demand for new construction should eventually help alleviate some of the supply constraints that helped home prices surge during the height of COVID.
Jobless claims rise: Weekly jobless claims edged higher last week, with 229,000 new claims filed, up from the prior week’s revised reading of 225,000 and still above the low of this cycle (182,000 set in September 2022). The prior two readings were revised significantly lower after fraudulent claims were uncovered in Massachusetts. The four-week moving average for claims came in at 231,250, unchanged from the prior weeks and 21 percent higher than the September low four-week average of 190,500. Continuing claims (those people remaining on unemployment benefits) remain elevated at just shy of 1.8 million. For further context, continuing claims were at 1.292 million in September 2022. While the latest numbers suggest the employment picture remains resilient, the increase in continuing claims over the past eight months may point to signs of early softening, as those who previously lost their jobs are having a harder time finding new employment.
The week ahead
Tuesday: We’ll watch The S&P CoreLogic Case-Shiller index of property values. Home sales and prices have continued to sag despite easing mortgage rates in recent weeks; however, inventory remains tight. We will be watching to see if the cooling of the housing market has tapered.
The Conference Board’s Consumer Confidence report will come out in the morning. Given the Federal Reserve’s ongoing focus on the employment picture, we will be particularly focused on the labor market differential, which is based on the difference between the number of respondents who believe jobs are easy to find and those who report challenges finding work.
Wednesday: The Bureau of Labor Statistics releases its Job Openings and Labor Turnover Survey report for April. February’s report showed job openings edging lower. We’ll be watching for any indications that the gap between job openings and job seekers is narrowing further, which may help ease wage pressure for businesses.
The Federal Reserve will release data from its Beige Book. The book will provide recent anecdotal insights into the nation’s economy and will highlight emerging regional economic trends.
Thursday: Initial and continuing jobless claims will be announced before the market opens. Initial filings were up last week, and we will be watching to see if recent signs of some softening in the job market continue.
The health of the manufacturing sector will be in the spotlight as the Institute of Supply Management (ISM) releases its latest Purchasing Managers Manufacturing Index for May. Recent readings have shown the manufacturing sector in contraction territory, and we will be watching for signs of change in the direction of the readings.
Friday: The Bureau of Labor Statistics will release the May Jobs report. In prior editions of this commentary, we’ve noted that a significant gap has emerged between the Nonfarm Payrolls report and the Household report. We’ll continue to watch for signs that this gap is narrowing as well as any changes in hourly earnings for workers to help gauge the state of wage pressures in the economy.
NM in the Media
See our experts' insight in recent media appearances.
Brent Schutte, Chief Investment Officer, discusses the latest inflation numbers and what they mean for interest rates and the likelihood of a recession. Watch
Brent Schutte, Chief Investment Officer, discusses what’s next for the Fed and the importance of diversification as a hedge against unexpected events in the markets. Listen
Brent Schutte, Chief Investment Officer, discusses U.S. and global economies as well as what the Federal Reserve needs to see before cutting rates. Watch
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As the chief investment officer at Northwestern Mutual Wealth Management Company, I guide the investment philosophy for individual retail investors. In my more than 25 years of investment experience, I have navigated investors through booms and busts, from the tech bubble of the late 1990s to the financial crisis of 2008-2009. An innate sense of investigative curiosity coupled with a healthy dose of natural skepticism help guide my ability to maintain a steady hand in the short term while also preserving a focus on long-term investment plans and financial goals.
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