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Distinguishing between signal and noise
Economic data at the best of times can be difficult to navigate. Analysis by professional business economists can often take differing interpretations of the same underlying data, while central banks will often examine the data through a different lens. This week, a slew of economic data releases confounded economists and markets. In this week’s brief, we will give our take on the most recent data releases and the implications for the economic outlook.
In general, two clear themes emerged over the week: (i) Disappointing economic activity; and (ii) a surprise and unwelcome pick-up in inflation momentum in the US. Within the first theme, we saw both the UK and Japan fall into a technical recession after contracting again in the December quarter. While the downward surprises to growth were only small and initial estimates of GDP can always be revised, the data highlights the broad-based weakness experienced outside the US in 2023. For the calendar year, real GDP growth was just 0.1% in the UK, a stark contrast to the 2.5% recorded in the US. The euro area was only marginally better, with flat growth in the December quarter and 0.5% for the year. Despite falling into recession, Japan did manage to record solid annual growth of 1.9% in 2023 thanks to a strong first half of the year.
This data does little to change our underlying view. Economic momentum in the UK and euro area should slowly improve over 2024 as the inflation headwinds diminish, although annual average growth is likely to remain anaemic at around 0.3% & 0.6% respectively. Japan should also emerge from recession this year, although growth will remain sluggish at around 0.5% in 2024.
The growth disappointments this week continued in the US, where retail sales were reported to have fallen 0.8% in January. While we take the view that inclement weather conditions and seasonal adjustment difficulties at the start of the year overstate the loss of momentum and a modest rebound is likely in February, we continue to expect the US consumer to slow in 2024. Our forecasts are for real consumption growth to slow from a 2.2% pace in 2023 to 1.7% in 2024, with rising unemployment, slowing wage growth, lagged impacts of interest rate hikes and an exhaustion of post-COVID savings buffers to constrain spending this year. Overall, we expect real GDP growth in the US to slow from 2.5% in 2023 to 1.8% in 2024.
While signs of softer underlying activity should increase the prospects for eventual rate cuts by central banks, the second major theme this week was a surprise and unwelcome pick-up in inflation momentum in the US. In monthly terms, the US core CPI rose by 0.4% in January, the highest monthly gain seen since April last year. As a result, the year-ended core CPI inflation rate remained unchanged at 3.9% in January, which was around 20bps higher than market expectations. Highlighting the loss of momentum, the three-month ended annualised rate of core CPI inflation picked-up to 4.0% in January from 3.3% in December and up from a low of 2.6% last August.
Examining the details of the US CPI release reveal a few notable drivers, including a surprise pick-up in owners’ equivalent rent and start-of-the-year price increases in medical care services, although overall the pick-up was broadly based across the services sector. We are inclined to look through much of the surprise due to concerns over seasonal adjustment early in the year and inherent noise in the monthly price data. We continue to expect inflation momentum to cool over the remainder of 2024. Forward indicators continue to point towards an easing in rent growth, while cooling wage growth should see core service inflation gradually trend down. We expect the core CPI inflation rate to ease from 3.9% in January to 2.9% by the December quarter, but not sustainably reach rates consistent with the Fed’s 2% PCE target until 2025.
The pick-up in US inflation momentum in January has seen significant repricing in bond markets over the week. US 10-year government bond yields jumped 15bps on the release, with the market repricing the extent of Fed cuts to around 100bps in 2024 from close to 150bps at the start of the month. Our view was that the Fed would be more cautious than market expectations, with our forecasts factoring in a first rate cut in June and 100bps over 2024. We retain this view on the expectation that the next four CPI reports before the June FOMC meeting will send a very different picture on inflation momentum in the US. However, a few further upward inflation surprises would no doubt see the Fed delay the commencement of their easing cycle.
Australia did not escape the trend towards economic data surprises this week. Australia’s monthly labour market report revealed the Australian economy added just 500 jobs over January, well below market expectations for a 25,000 gain. This is the second consecutive disappointment and has led the unemployment rate to rise to 4.1% in January, up from 3.6% in September. The monthly data tends to be very volatile, and we suspect some seasonal adjustment difficulties are also at play around the turn of the year. For this reason, we tend to prefer examining multiple months of data to gain a true reflection of the underlying trend in conditions. At this stage, we are not changing our forecast for a gradual increase in the unemployment rate to 4.5% by the end of 2024, but it does place significant onus on the upcoming February report to show some stabilisation in the data. Otherwise, the signal would clearly be towards a swifter-than-expected deterioration in labour market conditions, one that would likely lead to a faster moderation in inflation pressures and require the RBA to start its easing cycle earlier than our current expectations of late 2024/early 2025. The old adage from Keynes that “When the facts change, I change my mind” rings true, although in the world of noisy data releases it can take some time to be sure the “facts” are indeed changing and sending a true signal.