Inflation Comes Back in Focus
- Market attention was concentrated on the January consumer price data, as inflation has come back into focus. There is renewed concern among market participants that inflation is about to take off once the economy re-opens and demand accelerates. But, such concerns have not yet meaningfully presented themselves in consumer price data, with the core consumer price index unchanged for the month of January.
- While we expect inflation to firm later this year, we believe the Federal Reserve remains less concerned about inflation and more worried about labor market scarring. The labor market recovery continues to stumble, with an additional 793K workers having filed an initial claim for unemployment insurance last week.
- President Biden and Chinese President Xi had their first conversation this week since Biden was elected. Reports suggest numerous topics were discussed, but no new policy concerning tariffs was put in place.
Mixed Finish to 2020, Soft Start to 2021
- The European economy showed mixed, albeit overall subdued, trends at the end of last year. United Kingdom Q4 GDP surprised to the upside with a 1.0% quarter-over-quarter gain. In contrast, national level manufacturing data for December from the Eurozone were mixed, and Eurozone-wide industrial output is expected to fall 0.5% for December. The mixed trends were not just in Europe, with Brazil reporting a large decline in December retail sales but an increase in December overall economic activity.
- While 2020 finished on a mixed note, it is likely that Europe’s economy will show further weakness in early 2021. February PMI surveys are due from both the Eurozone and the U.K. next week. While the services PMI is expected to rise modestly for both economies, they are also expected to remain below the breakeven 50 level. That suggests a further (Eurozone) or renewed (U.K.) contraction in economic activity, and we forecast Q1 GDP declines for both economies.
Inflation Comes Back into Focus
It was a pretty quiet week in terms of economic data, with most market attention concentrated on the January consumer price data, as inflation has come back into focus. There is renewed concern among market participants that inflation is about to take off once the economy re-opens and demand accelerates. Inflation expectations have recently firmed, as higher input costs have pushed business inflation expectations to multiyear highs. Similarly, consumer inflation expectations have begun to trend higher. But, price acceleration has not yet meaningfully presented itself in consumer prices. The Consumer Price Index (CPI) rose 0.3% in January, but the gain was largely due to rising energy prices during the month. Excluding food and energy, core prices were unchanged from December, and over the past year, the core CPI is up just 1.4%, which is still significantly shy of the Fed’s 2% target.
That said, we do expect price growth to pick up over the course of the year. We recently made some fairly significant upward revisions to our 2021 and 2022 economic growth forecasts. Specifically, our outlook now makes the assumption that an additional COVID-fiscal relief package totaling roughly $1 trillion is passed by Congress sometime in March. With that in mind, we believe consumer spending, particularly on services, should ramp up markedly toward the second half of the year, as consumers rely on a mix of previously accumulated savings, still-flowing fiscal support and a pickup in job growth.
In this environment, prices are also poised to move higher. Low inventories and ongoing bottlenecks should continue to underpin goods inflation in the near term. But, once consumer spending begins to ramp back up, we expect service-sector inflation to be back in the driver’s seat. Consumers’ ample means to spend is set to collide with an eagerness to engage in activities put off by more than a year of social distancing. Shelter inflation (which represents a whopping 40% of the core CPI) should also begin its turnaround at that time, as the recent market conditions finally begin to be captured in the official CPI price data. After some low-base effects and support from oil prices,