The Pace Of Disinflation Is Stalled, Pushing Back The First Rate Cut Expectation Beyond June

Weekly Economic Review: April 1 & 8, 2024

The two weeks since our last Economic Review have been busy ones for economic news, and that news has not been good for those hoping for Federal Reserve action to reduce interest rates in the near term.  Let’s review some of the important economic data released so far this month.  

The month began quietly as the Institute of Supply Management (ISM) announced a mixed picture for both the manufacturing and the service sectors’ economic activities for March.  The ISM manufacturing index unexpectedly went up to 50.3 from 47.3, moving into expansionary territory (a reading above 50) for the first time since September 2022. However, the ISM Services PMI, the overall gauge of services, came in 51.4, falling short of the 52.8 forecast. This indicated a slowdown in the services sector growth for the second consecutive month.  The ISM Employment Index showed a continued contraction of services employment. The ISM Prices Index registered 53.4% in March, a 5.2-percentage point decrease from February’s reading of 58.6%, which is the weakest Prices Index reading since March of 2020.

The benign statistics continued on Tuesday when the Bureau of Labor Statistics announced its Job Opening and Labor Turnover Survey, indicating that in February, the number of job openings changed little at 8.8 million from prior month, suggesting stable labor demand albeit at an elevated level. The number of hires and total separations were little changed. The ratio of openings to unemployed people is down to a four-month low of 1.36.  The quits rate, the rate at which workers voluntarily leave their jobs, excluding retirements, held at 2.2% in February, the lowest since 2020.  The declining ratio of openings to unemployed workers is expected to abate wage pressures.

All that changed dramatically on April 5, when the Bureau of Labor Statistics announced that businesses added 303,000 new jobs in March, the largest growth since last May and far more than the 214,000-gain analysts expected.  The significant growth was primarily driven by health care, government, construction, and leisure and hospitality. In particular, employment in leisure and hospitality trended upward to 49,000, which has bounced back to its pre-pandemic level. 

The unemployment rate declined slightly as expected, to 3.8%. Wage growth increased 0.3% month-over-month, also as expected.  On an annual basis, wages were up 4.1%, which is the lowest growth since June 2021. The participation rate, which is the percentage of the population that is either working or actively looking for work, increased to 62.7%, the first advance since November.  These statistics were far less dramatic than the unexpectedly strong jobs numbers, and allowed investors to hold out some hope for near-term rate relief.

Those hopes were dashed by the April 10 release of the Bureau of Labor Statistics’ headline and core CPIs for March.  The inflation data exceeded forecasts for a third consecutive month, mainly driven by rising costs of gasoline and shelter. On a monthly basis, the headline CPI rose 0.4%, which is more than the 0.3% expectation and unchanged from the prior month.  On an annual basis, it accelerated to 3.5%, the highest since September.  This exceeded the 3.4% expectation and was up from 3.2% in February. Excluding food and energy costs, month-over-month, the core CPI rose 0.4% in March as it did in February and January, but was more than the 0.3% expectation.  On an annual basis, the core CPI rose 3.8%, which was more than the 3.7% expectation but unchanged from February.

Investors received somewhat better news the following day, when the Bureau of Labor Statistics announced the Producer Price Index, reporting that the PPI rose 0.2% in March. That was lower than the 0.3% expectation and the 0.6% gain in February.  The moderate gain in March was mainly because the cost of services was softened by a decline in goods prices. On an annual basis, producer prices rose 2.1%, up from 1.6% in February and 1.0% in January. Despite the sharp increase. the annual gain came in lower than expected. Excluding food and energy costs, the core PPI rose 0.2%, which is in line with the 0.2% expectation but down from 0.3% in February and 0.5% in January.  Year over year, the core PPI increased 2.4%, which is more than the 2.3% expectation and 2.0% from both February and January. Several items in the PPI that are used in the calculation of the Fed’s personal consumption expenditures (PCE) price index – its preferred inflation measure – came in softer. The PCE for March is due later this month before the next FOMC meeting scheduled from April 30 to May 1.

After digesting the jobs and inflation numbers, the market concluded that the blowout job number and declining unemployment rate indicate a strong labor market, one that will support continued consumer spending despite high prices and borrowing costs.  But the absence of progress on inflation will limit the Fed’s ability to reduce interest rates, and the two-year and ten-year Treasury yields increased significantly (by 0.29% and 0.30%) to 4.88% and 4.50%, respectively.  According to CME’s FedWatch Tool, the market pushed back its expectations for the first rate cut to September from June but still expects two to three rate cuts.  On a concluding note, while the robust labor market is a good thing for workers and the economy, the strong job creation and sticky inflation complicate the Fed’s rate cut outlook.  However, the increased participation and slowdown in average hourly earnings could help alleviate wage pressures.  Also, March’s moderate gains in producer prices lessened concerns about a resurgence of inflation.  At this point the market expects only a moderate increase in the Fed’s preferred PCE measure, offsetting the strong consumer price readings in March. If events play out that way, we may still see significant interest rate reductions in 2024, just not as quickly as had been hoped.

Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California

Thomas McCullough
EVP of Commercial Bank of California

_______________________________________________________________________

All content available on this material is general in nature, not directed or tailored to any particular person, and is for informational purposes only. Any of its content is not offered as investment advice and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. The information contained herein reflects the opinions and projections of Commercial Bank of California (CBC) as of the date hereof, which are subject to change without notice at any time. CBC does not represent that any opinion or projection will be realized. The information contained herein has been obtained from sources considered reliable, but neither CBC nor any of its advisors, officers, directors, or affiliates represents that the information presented on this material is accurate, current, or complete, and such information is subject to change without notice.