The week in the markets -
February 17, 2023

A tale of two economies

“If we had no winter, the spring would not be so pleasant.” — Anne Bradstreet, poet

On Tuesday, the U.S. Consumer Price Index (CPI) report for January started off a busy week of new data. Some specific highlights included an increase in inflation by 0.5% on a monthly basis (the highest gain since October). On an annual basis, CPI increased by 6.4% from a year ago, which was slightly lower than the 6.5% increase in December and higher than the 6.2% expected.

Housing was the main contributor to the monthly increase in CPI, making up nearly half the gain. Food, gasoline and natural gas also helped to boost monthly headline inflation. Owners’ equivalent rent (the measure for housing costs) gained 7.8% year-over-year. However, the super core inflation figure, which is a category that excludes housing from core services, showed some easing, increasing at a slower pace in the month and 6.2% from the prior year.

Although the data continues to trend lower, the report suggests that the road ahead for inflation is bumpy, with some months and categories showing persistent price pressure. Our thesis remains that inflation will continue on this lower path, but reaching the Fed’s 2% target may be more of a 2024 story.

It’s a tale of two economies right now; manufacturing and housing have slowed in Canada and the U.S. In fact, manufacturing growth in the U.S. is consistent with what we’ve seen in prior recessions. Additionally, U.S. housing starts have fallen 28% on an annualized basis since the peak of 1.8 million starts in April 2022.

Rising interest rates have had an effect on one side of the consumer economy, with demand for big ticket items, such as housing and cars slowing substantially. They haven’t had enough effect on the other side, however; retail sales (excluding vehicles) and the labour market (for now). Retail sales in the U.S. showed strong gains in January, growing the most in almost two years (with all 13 retail categories showing growth). Restaurants and bars had the biggest increase in sales, and it appears consumers are determined to keep on spending. The good news for consumers might mean a challenging environment for the U.S. Federal Reserve.  

A soft-landing scenario continues to be our base case, yet, without a more meaningful drop in inflation, central bankers have their work cut out for them. The U.S. Federal Reserve makes its next policy announcement in a month, with the market expecting an increase of 25 basis points, and we will be paying particular attention to any hint at forward guidance. In the meantime, let's celebrate the fact that Americans are still spending. It's hard to underestimate the power of the American consumer.