Policy and Struggles Overseas

December 16, 2022

In the wake of the Fed’s policy decision on Wednesday, yesterday the Bank of England (BOE) and the European Central Bank (ECB) followed suit with similarly sized policy initiatives.?

The BOE raised its policy rate 50bps to 3.50%, marking the ninth increase since December 2021. According to the statement, policy officials are increasingly concerned about forcing the economy into recession while at the same time remain focused on tackling inflation.?Of course, this is the same conundrum or balancing act Powell and Co. continue to face as policy intentionally slows domestic activity.?

Meanwhile, the ECB opted to raise rates 50bps, bringing the deposit rate to 2.0% and marking the fourth increase since the start of the year. The ECB also announced a reduction in its 5T euro stock of bonds. According to the statement,?"From the beginning of March 2023 onwards, the asset purchase programme (APP) portfolio will decline at a measured and predictable pace…The decline will amount to 15 billion euros per month on average until the end of the second quarter of 2023."

According to ECB President Christine Lagarde, more work needs to be done to quell inflation. Speaking at the news conference yesterday, Lagarde said,?“Anybody who thinks that this is a pivot for the ECB is wrong…We should expect to raise interest rates at a 50 basis-point pace for a period of time.”

While inflation remains still too high in the U.S., price pressures are even more elevated abroad amid ongoing supply-side constraints, particularly in the energy market, compounding the pressure on international monetary policy officials. In the U.K., annual November headline inflation remains near 11% with inflation near 10% in the ECB, underscoring the need for policy makers to focus on reinstating price stability as opposed to coddling market participants or providing perpetual artificial support to economic activity.?

Yesterday, retail sales dropped 0.6% in November, more than the 0.2% decline expected, according to?Bloomberg, and the largest monthly decline since December of last year. Year-over-year, retail sales rose 6.5% in November, down from the 8.3% gain in October.

Car sales fell 2.3% in November following a 1.6% gain the month prior, while gasoline stations sales declined 0.1% following a 4.8% rise the month prior. Excluding autos, retail sales fell 0.2% in November, but climbed 7.7% over the past 12 months. Excluding autos?and?gasoline, retail sales declined 0.2% but increased 6.7% year-over-year.

In the details, eating and drinking sales climbed 0.9% in November, following a 1.6% increase in October, food and beverage sales rose 0.8%, health and personal care sales rose 0.7%, and miscellaneous sales increased 0.5% in November.

On the weaker side, clothing sales declined 0.2%, sporting goods sales fell 0.6%, and non-store retailer sales dropped 0.9% in November. Also, building materials sales fell 2.5%, and furniture sales slipped 2.6% in November. Additionally, general merchandise sales decreased 0.1% in November, due to a 2.9% drop in department store sales, the second consecutive month of decline.

Bottom Line:?A slower-than-expected pace in consumer spending comes on the heels of a stronger-than-expected performance in October, leaving the average pace of expenditures still positive, but minimal at 0.3% thus far in Q4. Higher prices and higher borrowing costs, as well as negative real income growth continue to weigh on consumer activity, the backbone of the domestic economy.

Prior to yesterday’s release, some estimates showed a +3% growth rate at year-end. As we’ve noted before, while GDP is expected to remain positive in Q4, a 3% pace is unlikely. No doubt, following today’s retail sales figure, GDP forecasts will be revised down significantly.

Also yesterday, initial jobless claims declined by 20k from 231k to 211k in the week ending December 10, the lowest since September. According to?Bloomberg, claims were expected to rise to 232k. Continuing claims, meanwhile, or the total number of Americans claiming ongoing unemployment benefits, rose from 1.670M to 1.671M in the week ending December 3, the highest since February.

Additionally, industrial production declined 0.2% in November, following a 0.1% decline the month prior. According to?Bloomberg, production was expected to be flat. Capacity utilization, meanwhile, fell from 79.9% to 79.7% in November, slightly more than the expected decline to 79.8%.

The Empire Manufacturing Index dropped from 4.5 to -11.2 in December, more than the 1.0 decline expected and a four-month low. In the details of the report, the number of employees rose from 12.2 to 14.0 in December, a five-month high, and the six-month business outlook index increased from -6.1 to +6.3, a three-month high. On the other hand, prices paid remained steady at 50.5, while delivery time declined by one point to 1.9, and new orders slipped from -3.3 to -3.6 in December, a four-month low.

The Philly Fed Business Outlook Index, meanwhile, rose from -19.4 to -13.8 in December, less than the increase to -10.0 expected, and the fourth consecutive month of decline. In the details of the report, prices paid declined from 35.3 to 26.4, new orders dropped from a reading of -16.2 to -25.8, and employment plunged from 7.1 to -1.8 in December, the lowest reading since June 2020. Also, delivery time fell from -8.8 to -11.9, and prices received fell from 34.6 to 26.4 in the final month of this year. The six-month outlook index, meanwhile, gained from -7.1 to +3.8 in December, the highest reading since April.

Finally yesterday, business inventories rose 0.3% in October, slightly less than the 0.4% gain expected and following a 0.2% rise in September.

This morning, the S&P Global Manufacturing PMI declined from 47.7 to 46.2 in December, more than the expected decline to 47.8, and the lowest reading since May 2020. The services PMI, meanwhile, fell from 46.2 to 44.4 in December, more than the expected decline to 46.5 and also the lowest reading since May 2020. Additionally, the S&P Global Composite PMI decreased from 46.4 to 44.6 in December, a four-month low.

Later today, at 12:00pm ET, San Francisco Fed President Mary Daly will speak at a virtual event with Michael Strain, Director of Economic Policy Studies at the American Enterprise Institute, to discuss the Fed’s inflation response and the economy.

Ahead of Daly, New York Fed President John Williams suggested that?while inflation has improved somewhat, a tight labor market and other factors are likely to keep inflation?“elevated,”?warranting elevated rates for some time. Speaking on Bloomberg Television earlier today, Williams said,?“We’re going to have to do what’s necessary…It could be higher than what we’ve written down.”?Acknowledging the forecasts of some Fed watchers?that rates may need to go to 6% or even 7%, Williams was optimistic rates may not need to rise to that?“extreme”?given some favorable developments, including an easing of supply-chain dislocations and dysfunctions, and softer goods and imports prices.?

Next week, the economic calendar begins on Monday with the latest read on the NAHB Housing Market Index followed by the November read on housing starts and permits on Tuesday. Further housing market data comes on Wednesday with the latest mortgage applications report and the November existing home sales report and new homes sales report released on Friday. As the most interest rate sensitive sector of the economy, higher borrowing costs continue to weigh on housing market conditions and the level of affordability.?

Also on Wednesday, the latest read from the Conference Board on consumer confidence will be released, and later on Friday, the University of Michigan Consumer Sentiment Index will be released. Both are expected to show an ongoing retreat in optimism, already off more than 28.7 points and 29.2 points, respectively, from an earlier peak in 2021.

On Thursday, a number of regional manufacturing activity reports including the Chicago Fed National Activity Index and the Kansas City Fed Manufacturing Activity Index will be released, along with the final print on third-quarter GDP. After an initial report of 2.6%, third-quarter GDP was revised higher to 2.9% and is expected to remain at 2.9% in the final print.?

Finally, on Friday the latest read on durables, income, consumption and the PCE will be released. Despite the recent uptick in wages, inflation-adjusted growth in income has remained in the red since the start of the year, continuing to undermine the consumer’s ability to spend in the marketplace. While still positive, higher levels of costs and an increasingly fragile balance sheet have continued to weigh on consumers, resulting in a still positive, but markedly slower pace of activity, falling from an average of 8.6% in 2021 to 1.8% more recently.?

And finally, the latest read on the PCE, the Fed’s preferred measure of inflation will be released on Friday. As Federal Reserve Chairman Jerome Powell noted, prices remain too high. While down from an earlier peak of 6.8% in March, at 6.0% as of the October report, this remains 400bps above the Fed’s 2% target. In October, the PCE rose 0.3% and 6.0% year-over-year. Excluding food and energy, the core PCE rose 0.2% and 5.0% year-over-year. Looking out to the November release, the PCE is expected to rise 0.3% in November with the core also expected rise 0.3%.

?-Lindsey Piegza, Ph.D., Chief Economist?