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Chief Economist Eugenio J. Alemán discusses current economic conditions.

Today (July 7, 2023) was a good day for those that believe the Federal Reserve (Fed) has done enough to slow down economic activity in order to rein in the U.S. labor market as well as inflation, i.e., that is, for us! This doesn’t mean that the Fed is going to agree with us any time soon, but it helps us be more confident regarding our outlook for the second half of the year.

In our Thoughts of the Week for June 9, 2023, we indicated that there were sectors of the U.S. economy that had already created more jobs during the first five months of the year than during the whole of 2019, just before the COVID-19 pandemic recession. In our Thoughts of the Week for June 30, 2023, we also indicated that the jobs created during the first five months of 2023 represented 80% of all the jobs created in all of 2019. If we include today’s jobs, with six months of 2023 under our belts, this economy has created about 85% of all the jobs it created during twelve months in 2019. Thus, it is clear that employment growth will continue to slow down at a fast pace during the second half of 2023.

One sector that is extremely overstretched is government employment. After the first six months of this year, government employment is about 179% of what the sector had created for the whole of 2019. State government employment, which represents about 64% of all government jobs – 23% of government employment is at the local level while about 13% of government employment is at the federal level – is the largest culprit of the increase in total government employment in 2023. However, we expect overall government employment growth to slow down considerably during the second half of the year.

U.S. government jobs were up 60,000 during the month of June. However, it wasn’t the federal government that created most of the government jobs in June, it was state governments (up 27,000 jobs) and local governments (up 32,000 jobs). Thus, as we said above, government jobs are due for a strong slowdown during the second half of the year. Another sector, but much smaller, was mining and logging. In this case, the sector showed a decline of 1,000 jobs in June.

Employment in wholesale trade, retail trade, transportation and warehousing as well as in the utilities sector showed declines in employment in June also, adding support for our view that employment growth is slated to continue to weaken during the second half of the year. Furthermore, some of the sectors that were lagging behind job growth compared to 2019 continued to post strong job growth. This is especially true for the health care and social assistance sector, which typically does well during periods of economic weakness because of the needs of our aging population. Thus, strong job growth in this sector should not be a big concern for Fed officials as they decide what to do with the federal funds rate going forward.

Housing inflation has finally peaked

Adding to our expectations for the U.S. labor market, housing costs are starting to weaken and will start to put inflation on a faster disinflationary path during the second half of the year. Both, the Consumer Price Index (CPI) – the Shelter Cost Index – as well as the Housing Price Index for the Personal Consumption Expenditures (PCE) Price Index have started to pivot on a year-over-year basis. The process is just starting and will take some time to become more apparent, but it will hopefully convince the Fed that it doesn’t need to go much higher in terms of interest rates to continue to see the disinflationary process move forward.

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The most important reason for this is because shelter costs have a weight of about 34% in the calculation of the Consumer Price Index and a weight of approximately 16%-18% in the calculation of the PCE Price Index. This means that shelter/housing costs are very important not just in determining the future path of the disinflationary process but also in determining the speed at which this disinflationary process is going to move.

The biggest issue for the Fed today is still the strong pace of growth shown by the U.S. service sector, as reflected in yesterday’s release of the ISM Services PMI, which showed a stronger service side of the economy during the month of June compared to May. This could keep service sector prices relatively strong if the sector doesn’t slow down during the second half of the year.

However, even a relatively strong service sector will continue to allow for the disinflationary process to move forward. Thus, we continue to recommend patience as we expect the U.S. economy to continue to slow down in the months ahead, which will be enough to keep inflation on a disinflationary path and inflation expectations well anchored.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren’t part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy’s movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners’ currencies. The Index goes up when the U.S. dollar gains “strength” when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers’ Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 7/7/2023