Financial News for the Week of April 14th, 2023

Rounding the corner into earnings season, a sense of calm seemed to descend across financial markets this week in financial news. But with earnings season not officially in full swing until Friday morning, investor focus fell squarely on the economic data. The two headliners this week were the March readings of CPI inflation and retail sales, though the release of the FOMC meeting minutes also garnered some attention.

The latest move by the Federal Reserve occurred during the recent regional banking crisis, which ultimately forced the FOMC to rethink its trajectory for the federal funds rate.  The uncertainty was on full display in the minutes, where several participants thought it was appropriate to hold the target range steady last month in light of recent events. This was an abrupt U-turn from what policymakers had communicated just a few weeks prior to the interest rate announcement, where the thought was rates needed to move both higher and faster relative to what had been assumed in the December’s Summary of Economic Projections. But perhaps the most noteworthy takeaway from the minutes was an explicit mention that considering the recent banking crisis “… the staff’s projection included a mild recession starting later this year, with a recovery over the subsequent two years”. Indeed, participants agreed that the actions taken by the Federal Reserve and other government agencies helped calm conditions in the banking sector but deemed that it was still too early to assess the confidence and magnitude of the effect of credit tightening on the real economy.

This morning’s retail sales gave a first glimpse into the impact that tighter credit conditions may already be having on households. Both nominal and real spending fell 1.0% m/m in March, marking the second consecutive month of declines. But even after accounting for the pullback, consumer spending is still tracking a robust 4.2% for Q1 in financial news. However, the weak handoff from March suggests last quarter may have been the “last hurrah” as the cumulative effect of higher interest rates alongside the recent tightening in lending standards appear to be bearing down on the consumer.

From an inflation standpoint, the softening in demand has yet to manifest in any significant easing in core consumer price pressures. Indeed, headline inflation slipped to 5% y/y – a near two-year low – thanks to lower food and energy prices (Chart 1). However, core CPI rose 0.4% m/m, leaving the 3-month (annualized) and 12-month rates of change at 5.1% and 5.6%, respectively. Underpinning the gains was an acceleration in goods prices alongside continued strength in shelter (0.6% m/m) and non-housing services (0.3% m/m).

For a central bank who has become increasingly data dependent, the continued persistence in core inflation alongside the recent uptick in inflation expectations is unlikely to sit well (Chart 2). Provided there are no further flare-ups in financial markets, it is likely that the FOMC will need to raise the benchmark rate by another 25-bps in May, before pausing to better assess the full impact of the 500-bps of rate hikes.

 

Thomas Feltmate, Director & Senior Economist | 416-944-5730