US Economy: Weekly Commentary – February 19, 2024.
Synopsis of US market sentiments
Increasing inflation pressures with Housing sector putting more pressure on prices. Consumer spending dropped. Manufacturing sector improve modestly in January. Fed will hold rate at least until the second half of the year.

U.S. economic indicators show strong price pressures, diminishing the likelihood of rate cuts soon. January's CPI and PPI registered a 0.3% MoM increase. Bond yields and dollar increased, and gold prices dropped. Inflation concerns persist, and challenges in housing include high mortgage rates and low inventory. January's unexpected 0.8% MoM drop in retail sales signals potential sector weakness. The manufacturing sector experienced a 0.5% MoM output decrease. The Federal Reserve will hold rates for longer.
Inflation commentary
Strong prices put pressure on the Federal Reserve to consider holding rates at the current level. The chances of rate cuts in March have evaporated, with May also unlikely. Bond yields increased have reacted long with a strengthening US dollar. This is in line with our thoughts we have been conveying since last year that cuts will occur in H2.

In January, inflation in the United States experienced a 0.3% increase (vs 0.2% Dec). On an annual basis, it recorded a rise of 3.1% (vs 3.4% Dec). Core inflation remains stagnant at 3.9%, still well above the target, presenting issues for the Federal Reserve in considering rate reductions. Core services, excluding housing inflation, surged by 6.7% on a three-month annualized basis.

Upward surprise is notable in the housing sector, with a 0.6% MoM increase, primarily driven by owners' equivalent rent, which also rose by 0.6%. As previously noted in our reports, prices are unlikely to decline until the supply increases. Airline fares experienced a 1.4% MoM rise, while medical care, recreation, and education each saw a 0.5%, 0.4%, and 0.4% increase, respectively. Notably, these three categories witnessed their fastest rate of increase in several months. On a positive note, prices for used cars, general goods, and energy declined, indicating a potential concentration of deflation in specific categories.

The market was optimistic about overcoming inflation and investors have been discussing about the number and magnitude of anticipated rate cuts throughout the year. Companies that previously fuelled market growth are now, with the new scenario around inflation, facing challenges again with high rates, potentially leading to a correction. However, this scenario is well for gold and fixed-income investments.

Speculation on the Federal Reserve's rate cuts has shifted, with expectations pointing towards June rather than March or May. The rebound in core inflation, considered crucial by the Fed, is attributed to the robustness of the American economy. Controlling salaries will play a pivotal role in managing inflation, as other variables like oil and food prices remain beyond their control. Our outlook anticipates the FOMC maintaining the Fed funds rate in March and initiating an easing cycle in the latter half of the year with just two cuts.
The PPI data surprised by registering a 0.3% MoM increase in January, a reversal from the -0.1% decline observed in December. Core PPI, excluding volatile components, also saw a notable 0.5% MoM rise in January (-0.1% MoM Dec). Despite energy still contributing to deflation, its pace appears to be waning. On an annual basis, both the headline and core PPI surpassed expectations, with a 0.9% and 0.2% increase, respectively. The Federal Reserve's ongoing battle against inflation, particularly in the services sector, continues. Wholesale inflation levels are anticipated to remain elevated for a more prolonged period than currently anticipated by the market.

We expect more increase in CPI in the coming months taking as a reference the recent PPI rebound. Inflation will be higher for more time than the market expected.
Housing market
The housing market is still far from a recovery. The mortgage rates remain high, affordability is an issue, and low inventories don’t help to reactivate the market. Homeowners already locked into low mortgage rates and are unwilling to list their homes. Building permits and housing starts dropped in January.

Mortgage applications decreased by 2.3% from the previous week. Refinance applications fell 2% from the previous week but were still 12% higher than last year. This is because mortgage rates have risen again, reaching almost 7% again in the 30th year. Particularly, the 30-year fixed mortgage increased 7bp in the week ended February 9 to 6.87%. Purchase applications remained subdued as elevated rates continued to add to affordability challenges along with still-low existing housing inventory. Refinance applications declined and remained depressed, with rates still higher than a year ago. Home buyers and sellers alike have been awaiting a sustained drop in mortgage rates, which have come down from their peaks near 8% in the fall but are still double their levels from late 2021. The Federal Reserve has signalled a willingness to cut rates this year, but inflation has been contrary. Borrowing costs risk staying elevated until further progress is made bringing inflation closer to the Fed’s goal.

Housing Starts experienced a significant 14.8% MoM decrease in January. Building Permits also saw a decline of 1.5% MoM, falling short of the expected 1.3% increase and showing a notable drop from December's 1.8% MoM. The prospect of permits rebounding seems unlikely shortly, given the recent resurgence in mortgage rates. This development doesn't bode well for the CPI either, as it suggests a lack of relief in rental costs.

Our perspective is more increases in prices in the coming months due to the lack of supply (low inventory), which could push the inflation higher (important category in CPI). Besides, the market is far from a recovery.
Consumer spending
Retail sales dropped in January more than expected. January, historically trended to decrease after a strong consumption in December.

Retail sales fell 0.8% in January (vs +0.4% Dec) marking the biggest monthly drop since March 2023. After stripping out the auto and gas categories, core retail sales fell 0.6%, compared to expectations for an increase of 0.2%, which dragged the YoY levels down to their lowest since the COVID lockdowns. American consumers finally show signs of stress in the face of higher interest rates and inflationary pressure. If this data is adjusted for inflation, it represents a drop of 2.4%, which is a huge drop.

By category:
Motor vehicles and parts and building materials saw the largest decline in MoM. On an annual basis, gas stations and building materials were the biggest drag, while online retail sales and food services were the biggest upside drivers.

In general, this is good data for the market, especially for the bond market. If retail sales are cooling, it is difficult for prices to continue rising. We expect more weakness in retail sales in the coming months.
Business activity commentary
The manufacturing sector starts the year with weakness. Inflationary pressure remains. The labour market is tight among manufacturing companies.

In February, both regional manufacturing indices, incorporating data from the New York and Philadelphia Fed regions, demonstrated a rebound following recent weakness. In Philadelphia, there was an uptick in both new orders and shipments, whereas in New York, orders declined while shipments increased modestly. Unemployment saw an increase in Philadelphia, remaining stable in New York, and prices experienced a rebound in both regions. Firms are anticipating a 3% increase in their product prices and U.S. consumer inflation over the next year. Despite these positive developments, the impact was not reflected in the January industrial production report.

The manufacturing sector initiated the year in a bad way, with output decreasing by 0.5% MoM. Mining output witnessed a 2.3% MoM decline, yet utility output surged by 6%, resulting in a marginal 0.1% MoM decrease in overall industrial production. In our view, the sector will present weakness until the Fed cuts rates.
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