Chief economist Simona Mocuta muses on seasonal oddities in US data and why they caution against an overly hawkish interpretation of the recent data flow.
A sequence of stronger-than-expected US data prints – the January payrolls, inflation, and retail sales in particular – has triggered another bout of soul searching around the disinflation narrative and a meaningful repricing of the Fed Funds rate trajectory for the rest of the year. The market now anticipates a higher rate peak and a slower descent from there, with year-end Fed Funds rate priced at some 80 basis points higher than what was at the start of February (Figure 1).
For our part, we think the disinflation narrative remains well anchored and the reaction to the latest data is overdone. One should never allow a single set of monthly data – nor a sequence of releases referencing a single month – to completely sway one’s perception of underlying economic trends. After all, one month does not make a trend! That is doubly so for January data in any given year and even more so in the post-COVID-19 world.
We had argued at the very onset of the pandemic that such an unusual and outsized dislocation in economic activity would render seasonal adjustments extremely challenging for some time to come. Subsequent waves of COVID-19 accompanied by fiscal stimuli certainly did not make the job any easier. Indeed, we believe seasonal adjustment oddities (partly weather-driven) bolstered many of the January releases, and so, caution should be exercised in their macroeconomic interpretation.
To be sure, we were the first to acknowledge a welcome degree of resilience in the US economy. In fact, it is precisely because we anticipated such resilience months ago that we have never shifted into the “recession is inevitable” camp even as data disappointments abounded in the fourth quarter. For some years now, we have observed a pattern of strong early start to the holiday shopping season followed by softness thereafter, usually with an outright contraction in December and an outsized rebound in January (Figure 2).
This was the reason why we did not get too despondent about the November-December softness and why we cannot get overly excited about the January rebound. The data oddities become even more difficult to ignore when one dives deep into some of the retail sales sub-components. The 17.5% month-over-month (MoM) surge in department store sales in January, the 7.2% MoM jump in restaurant and bar sales and the 5.9% monthly increase in vehicle sales are not only unsustainable but look downright odd (Figure 3).
Odd or not, the apparent strength in January data has not only reignited but has even settled the argument in favor of further tightening to bring inflation under control. The Federal Open Market Committee (FOMC) has willingly recognized the improvements in core goods inflation – how can this be denied when core goods inflation dropped from over 12.0% year-over-year (YoY) in February 2022 to just 1.4% YoY this past January? The Fed is even willing to concede that shelter disinflation will begin later this year, warranted by the sharp moderation seen in newly set/transacted rent and house price inflation.
It is the fate of non-shelter services inflation that still troubles the Fed greatly as wage inflation in that space remains too high to be consistent with the 2.0% inflation target. We agree that current levels of wage inflation remain too high to be consistent with the 2.0% inflation target, but they are not inconsistent with a material deceleration in inflation toward the target.
Importantly, even with the 500K+ jobs added in January, average hourly earnings growth slowed on a YoY basis not only for the entirety of the employed population but also for production and non-supervisory employees, whose wage gains have been most robust over the course of the recovery. Wage inflation in key non-housing service sectors has been decelerating more or less steadily for about a year, which brings the Fed’s current monetary policy stance in sharp focus (Figure 4).
The long and variable lags of monetary policy may actually argue in favor of letting the already delivered tightening measures to work through the economy. Not long ago, policymakers used to argue that once the whites of inflation’s eyes are visible, one has waited too long to tighten. By the law of symmetry, could it also be true that if one keeps tightening until the whites of disinflation’s eyes are seen, one may have gone a step too far?
Admittedly, the FOMC sees inflation risks as still skewed to the upside – a view which recent data will solidify – and the risks of doing too little are far greater than doing too much. Both types of risks, however, become fully visible only in retrospect. For our part, we see the disinflation narrative as well anchored and continuing to unfold through the rest of the year and into 2024. Even with the January data in hand, the year-end inflation forecasts from the December Summary of Economic Projections look reasonable. For example, in order for the core personal consumption expenditures forecast to materialize, the average monthly increase would need to slow just a tenth relative to the 2022 average, namely from 0.38% MoM to 0.28% MoM.
To believe that all the tightening of the past year would not be sufficient to drive even that much incremental moderation equates to a rather extreme scenario, in our view. This is why we do not see the need for additional rate hikes beyond what has been penciled in the December dot plot, namely a terminal rate of 5.25%.
To be fair, we had previously anticipated the Fed to end the tightening cycle with a final 25 bps rate hike at the March meeting, but recent developments have made another hike in May pretty much a done deal. It is also true that the FOMC is under a lot of pressure to display unwavering commitment to fighting inflation, especially since the associated costs appear so well contained.
As such, there is a considerable risk that the March “dots” would show an even higher peak, especially since the departure of former Vice Chair Lael Brainard removes a dovish voice from the group. Should that be the case and if the tightening cycle extends to mid-year, it would become that much harder for the FOMC to begin calibrating the Fed Funds rate lower before the year-end, which had also been our expectation.
We acknowledge considerable risks to our dovish views, but the end of 2023 is still a long way off, and a lot can happen in the meantime.
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