economic update Quarterly Economic Review and Outlook

BY: METRO

Headline inflation is too high and well above expectations; FED response was to raise its benchmark interest rate by another 25 basis points; Labor market conditions remain tight giving impetus for the FED to tighten financial conditions; US GDP growth outpaced expectations and chances of a mild recession diminish (at least for now)

US Inflation (Consumer Price Index – CPI)

US inflation has shown modest signs of easing but remains stubbornly high. The rate dipped to 6.0% in February, easing from 6.4% in the prior month. This is a welcome trend, especially after inflation had peaked to 9.1% last June ’22. Energy and fuel costs had spiked and significantly added to last year’s inflation rate but has since eased. Inflation remains elevated because rent inflation has partly replaced high energy prices as the key contributor to higher-than-expected headline inflation. According to BLS (Bureau of Labor Statistics) rent data for US cities, the increase in contract rents accelerated to 8.8% on a 12-month basis in February, over double the rent inflation from a year ago (4.2%). As the FED lifted interest rates, it drove down affordability for firsttime home buyers. This led to an increase in rent inflation as more households remained stuck in apartments and couldn’t afford to buy a house with mortgage rates that had sharply risen.

Bottom line: Higher interest rates have yet to quell the headline inflation rate. Financial conditions will thus remain tight for the remainder of this year because of the FED’s price stability mandate. Pundits believe rent inflation will taper significantly later this year as lease renewals turn over with lower rent increases which will help alleviate some of the pressure on the FED to act.

US Federal Reserve (FED) Policy

The FED’s chief concern stems from a fear that high inflation expectations become permanently embedded in the US economy. The Central Bank has undertaken steps during the last 12 months to tighten its grip, including sharply lifting interest rates and reducing its immense portfolio of mortgagedbacked and US Treasury securities. The FED’s latest action on March 22nd was to lift its benchmark interest rate 25 basis points to a range between 4¾% to 5%. Central bankers at the FED reiterated their restrictive monetary stance, despite the collapse of Silicon Valley Bank in California and Signature Bank in New York.

Bottom line: Expect more economic headwinds and crosswinds that will impede the FED. The spate of bank failures is an unintended consequence, but it has not lessened the FED’s resolve on fighting inflation. The FED will continue taking forceful actions, but recent banking woes have raised the degree of uncertainty of its actions. The FED will have to move with greater caution. Steps it may take to quell inflation will be smaller. In the end the FED will have to maintain greater vigilance for a longer duration if it is to achieve its goal of price stability.

US Labor Market

The FED’s efforts to slow US economic growth and impede inflation have not yet yielded the decline that central bankers had hoped. US growth has exhibited far greater resilience than expected, especially labor markets. At current rates of unemployment and job growth, the US labor market remains tight. The unemployment rate in the US has bounced around 3.5% since a year ago. US unemployment claims have edged up in recent months but one must squint hard at the data to see the trend. Unemployment remains near the lowend, offering little indication of weakness in US labor markets at this juncture of the business cycle. Employment has rebounded above pre-pandemic job levels and the job market continues to register strong monthly gains, although it is clear that annual growth has begun to slow with the latest labor report showing growth of 3%.

Bottom line: The US labor market continues to register strong monthly gains, enough to absorb jobless claims and hold down the monthly unemployment rate. With recent GDP and other economic indicators registering positive or tapered gains, the current strength in labor market conditions is likely to carry forward for a while longer. Expected weakness in the US labor market will be deferred to subsequent quarters this year.