HIGHLIGHTS OF THE WEEK

  • Financial markets moved sideways, rising in the first half of the week and sliding lower thereafter, but ultimately ending the week in the black.
  • Economic data was more consistent, surprising to the upside. After three lackluster months, retail sales jumped 0.6% in March. Housing starts also posted a decent rebound rising by 1.9% on the month.
  • Rising input costs a stood out prominently in the latest Beige Book, but comments from Fed speakers saw little cause for alarm or the need for more aggressive interest rate increases

 

 

The Fed Preaches Patience Amid Rising Inflation Tide

Markets moved sideways this week, rising in the first half and sliding thereafter, even as energy stocks rallied. Still, there was no shortage of economic data and Fed speeches, giving investors plenty of news to digest.

For its part, economic data surprised to the upside. After three lackluster months, retail sales jumped 0.6% in March and the core measure rose by 0.4%, beating market expectations. March was the first full month where taxpayers would have felt the impact of tax cuts on their paychecks, raising the bar for retail sales. This week’s report did not disappoint. Consumers responded to higher after-tax income by ramping up spending on most categories of products, particularly on discretionary and big-ticket items, such as autos, furniture, electronics & appliances, as well as at online retailers. While the strong print in March comes a little too late to save first quarter consumer spending, it sets up second quarter for a healthy rebound, with consumer spending likely to grow around 3%.

Housing starts also posted a decent rebound in March, rising by 1.9%. However, details were slightly softer than suggested by the headline. The gain was concentrated in the volatile multi-family segment, while single-family starts declined. For the first quarter as a whole, homebuilding has outperformed our expectations; however, it remains low relative to underlying demand and history. Even though economic fundamentals remain strong, a shortage of workers, available building lots, as well as risings costs of labor and materials continue to weigh on homebuilding activity. These headwinds are contributing to tight inventory of houses on the market.

Rising inflationary pressures also stood out prominently in the latest Federal Reserve Beige Book. Businesses reported rising steel prices in the aftermath of the tariff announcement. Prices for building materials, such as lumber, drywall, and concrete, also continued to rise briskly. Transportation costs, meanwhile, increased on the back of higher fuel prices, with oil prices rising to the highest level in more than three years this week. Labor shortages were also reported across a wide range of industries and skills. All in all, businesses are increasingly facing rising input costs for both labor and raw materials, and with declining unemployment, strong economic growth and the risk of further tariffs, this trend looks set to continue. It is likely only a matter of time before companies pass these higher costs onto consumers, ultimately pushing inflation higher (see our recent report).

Nonetheless, this week’s many Fed speakers downplayed the need for faster rate hikes. New York Fed President William Dudley said that the case for “tightening policy more aggressively is not compelling”. Meanwhile, Federal Reserve Vice Chair Randal Quarles said that he didn’t view recent flattening of the yield curve as a signal of an imminent recession. This suggests that the Fed remains on track (but not in a hurry) for continued gradual interest rate normalization.

 

Ksenia Bushmeneva, Economist | 416-308-7392

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