Economy (and Inflation) Starts 2023 Stronger than Expected

Key Takeaways:

• The Consumer Price Index (CPI) increased 0.5 percent in January, its strongest gain since October 2022, according to the Bureau of Labor Statistics (BLS). In addition, the BLS updated the seasonal adjustment factors and weights used to calculate the CPI, which generally caused downward revisions to the monthly inflation reports in the middle of 2022 and upward revisions to the last quarter. On an annual basis, prices rose 6.4 percent, a deceleration of one-tenth from December. Both used cars and trucks and airline fares provided drags to the CPI, declining 1.9 percent and 2.1 percent, respectively, while gasoline partially reversed its recent downward trend and rose 2.4 percent. Excluding food and energy, core CPI rose 0.4 percent in January and 5.6 percent annually, a deceleration of one-tenth compared to December. Shelter costs remain a major contributor, rising 0.7 percent over the month and 7.9 percent over the year.
• The Producer Price Index (PPI) increased 0.7 percent in January, its largest monthly gain since June 2022, though it slowed to 6.0 percent on an annual basis, a deceleration of five-tenths from December, according to the BLS. As with the CPI, revisions to the seasonal factors generally caused higher month-over-month readings for the PPI at the end of last year. Final demand for goods prices jumped 1.2 percent as energy prices surged 5.0 percent, while final demand for services prices were up 0.4 percent. Core PPI (less food, energy, and trade services) increased 0.6 percent over the month and 4.5 percent over the year.
• Retail sales and food services jumped 3.0 percent in January after two consecutive monthly declines, according to the Census Bureau. Sales at motor vehicle and parts dealers and bars and restaurants were particularly strong, increasing 5.9 percent and 7.2 percent, respectively. Core retail sales, which exclude food services, autos, building supplies, and gas stations, were up 1.7 percent.
• Industrial production, a gauge of output in the manufacturing, utility, and mining sectors, rose 0.1 percent in January, according to the Federal Reserve Board. The small uptick was despite a 9.9 percent drop in utilities output, coinciding with unseasonably warm weather over the month. Manufacturing output increased 0.9 percent after two consecutive monthly declines and mining output rose 2.0 percent.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index increased 0.5 points to 90.3 in January. Businesses continued to report tight labor market conditions as the share of firms with positions they are unable to fill rose 4 points to 45 percent and 46 percent of firms are raising worker compensation, up 2 points from December. On net, 26 percent of firms expect lower earnings this quarter, 4 points fewer than last month. A plurality of businesses still rank inflation as their single most important problem, though the measure was down 6 points to 26 percent.
• Housing starts declined 4.5 percent to a seasonally adjusted annualized rate (SAAR) of 1.31 million in January, according to the Census Bureau. Single-family housing starts were down 4.3 percent to a SAAR of 841,000 and multifamily starts fell a similar 4.9 percent to a SAAR of 468,000. Single-family permits continued a steady decline, dropping 1.8 percent to a SAAR of 718,000, while multifamily permits rebounded somewhat, rising 2.5 percent to a SAAR of 621,000.
• The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index increased 7 points to 42 in February, its highest level since September 2022. The index for single-family sales in the present rose 6 points to 46, while the index for single-family sales in the next six months jumped 11 points to 48. The index for foot traffic of prospective buyers rose 6 points to 29.

Forecast Impact:

This week’s data releases suggest the economy started 2023 on a significantly stronger footing than we had expected. Starting with retail sales, the apparent jump in consumption coincides with a general loosening of financial conditions to start the year, a strong month of reported payroll gains, and an 8.7 percent increase to Social Security Cost-of-Living Adjustments. Still, we suspect there are ongoing issues with the seasonal adjustments around the holiday shopping season, as retail sales were reported to have jumped 5.5 percent in January 2021 and 2.5 percent in January 2022, both coming off negative December readings. On balance, this report will cause an upgrade to our Q1 consumption expectations, though we suspect that November and December were likely stronger than reported and January somewhat weaker. Manufacturing output was also stronger than expected, though we’re discounting this somewhat as well because it remains at a low level and was likely helped by unseasonably warm weather in January. On the inflation front, updates to the seasonal adjustment factors suggest inflationary pressures are stickier than we had previously thought. Although we continue to believe that inflation is generally trending downward, the rate of disinflation looks to have slowed (or perhaps leveled out altogether) and underlying inflationary pressures remain above the Fed’s target. We will likely be upgrading our near-term CPI forecast. Additionally, we see upside risk to our current terminal federal funds rate forecast and therefore interest rates more generally.

Homebuilder optimism increased during the first two months of 2023, though that didn’t translate into higher starts in January. Though single-family starts have bounced around a bit in recent months, the steady decrease in new permits suggests this report is largely in line with our expectations for ongoing weakness in new home starts this year. Fundamentally, builders currently have a large inventory of new homes for sale that have already been completed or are under construction, so we expect builders will focus on completing and selling those previously started homes rather than breaking ground on new projects.

Nathaniel Drake
Economic and Strategic Research Group
February 17, 2023

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