Signs of A Cooling Economy Are Everywhere - 5.16.24

by Ryan Schoen , Sr. Insight Analyst

Quick Hit

This week we received evidence that the U.S. economic train is slowing. The market received its first downside surprise in inflation since the turn of the year, easing concerns that inflation might reverse and trend higher. At the same time, we discovered that U.S. consumers could be reaching their breaking point in battling elevated inflation levels and the highest interest rates on consumer debt in decades when a significantly weaker-than-expected retail sales report was released. Signs of a slowing consumer and, therefore, economy were confirmed just yesterday as well when data revealed a surging deterioration in consumer debt transitioning into delinquent status.?

In response, market participants began increasing the odds for two rate cuts this year, with the first occurring in September. The renewed optimism around future rate cuts sent the S&P 500, Nasdaq, and Dow to record highs, treasury yields to their lowest levels in more than a month, and daily 30-year fixed-rate mortgage indices to print rates with a 6 handle (a 50 bps move lower in just two weeks).

Key Points & Stats

1. Headline CPI increased 0.31% in April, slower than the monthly pace set by the previous two readings, to 3.36% annually. ?
2. Core CPI increased even less at 0.29% in April, to an annual rate of 3.62%, representing the lowest reading since April 2021. ?
3. Retail sales were essentially flat in April, growing just 0.02%, following a downwardly revised 0.65% gain in March. ?
4. The core “control group” of retail sales, which feeds directly into GDP and PCE calculations, fell by 0.25%, contrary to expectations of a small rise. ?
5. Aggregate delinquency rates increased in 1Q2024, with 3.2% of outstanding debt in some stage of delinquency at the end of March. Annualized, approximately 8.9% of credit card balances and 7.9% of auto loans transitioned into delinquency, the highest levels since the end of 2010. Mortgages in the transition to 30+ days delinquent status hit 3.24%, just 0.24% from pre-pandemic levels, but still low by historical standards.
6. While Fed officials are in no rush to cut rates, these three recent economic reports suggest a cooling economy that could prompt officials to reconsider the timing of their moves should we continue to string a few of these weaker economic data readouts together. ?

Inflation Pressures Ease in April

The Bureau of Labor Statistics reported that consumer prices rose at their slowest pace in three months and can be taken as a positive sign that the previous three hotter-than-expected CPI reports could potentially have just been bumps in the road instead of a sign that larger problems could persist in getting inflation to return to the Fed's target goal of 2%.

Taken together with last week's unemployment rate update, it appears that we are on the desired path of maximum employment and stable prices or an unemployment rate near 5% and annual inflation rate near 2%.

Further cementing the good inflation news is the fact that inflation, after stripping out the lagging shelter component, has come in around the 2% mark for the 12th consecutive month.

The shelter component did ease to 5.5%, its lowest annual rate since May 2022, but it continues to provide upward pressure on overall inflation. However, more timely private sector data shows that this should continue to ease in the coming months.

U.S. Consumers Could Be Reaching Their Breaking Point

The weaking labor market, elevated inflation levels, and financing costs sitting at their highest levels in a decade are finally taking a toll on American households as U.S. consumers cut back on spending.

The latest report from the U.S. Department of Commerce surprised economists when it came in essentially flat to the prior month, well below expectations for a 0.4% increase.?

By sector, the biggest monthly increase in spending was at gas stations where sales increased 3.1% in April compared to March on the back of surging prices experienced over the previous two months. Spending was also higher at clothing and accessory stores (+1.6%), food and beverage stores (+0.8%) as well as at restaurants and bars (+0.2%).?

Almost all other sectors saw monthly declines, with online or nonstore retailer sales falling the most at 1.2%.

More importantly, the core “control group” that includes all U.S. retailers, except for food, cars, construction materials, and motor fuel, showed a decline of 0.25%.?

Excluding these groups provides meaningful insight into consumer spending due to the high volatility of their prices. For example, prices for seasonal products increase when they have to be imported from other countries or other climatic zones. Cars are considered to be highly volatile for general retail sales because of the high price per unit. Therefore, even a small increase in the number of units sold leads to an increase in the monetary volume of retail sales. Construction materials are also excluded from the calculation due to seasonal characteristics: construction and renovation are traditionally more active in summer, and therefore retail sales grow at this time. Retail motor fuel sales also increase in summer, when people travel by car across the country.

This is also a noteworthy development since it feeds directly into the GDP and PCE calculations that are important in the Fed's decision-making.

Cracks Emerge in Households Meeting Their Financial Obligations

Evidence that consumers are feeling the financial pinch further supports the slowdown in retail spending and resumption of disinflation.

The NY Fed gave us a glimpse into some troublesome trends as an increasing number of consumers fell behind on their credit card, auto loan, and mortgage payments at the start of the year. Annualized, approximately 8.9% of credit card balances and 7.9% of auto loans transitioned into delinquency, the highest levels since the end of 2010. Mortgages in the transition to 30+ days delinquent status hit 3.24%, just 0.24% from pre-pandemic levels.?

As of now these trends are welcome news as we need weakness to gain control over inflation and receive lower rates as a result, but there will come a tipping point when bad news is truly bad news. A potential lifeline that could funnel more money to consumers and keep spending elevated is if the GSE's start buying second mortgages, unlocking trillions in home equity. Only time will tell if that comes to pass.