May 2023 / VIDEO
Stubborn Services Inflation Keeps Fed on Guard
Key Insights
- U.S. economic growth in the first quarter slowed notably from late 2022, but this was mainly driven by inventory declines.
- The labor market also appears quite resilient, though layoffs have spread beyond the tech sector.
- We’ll need to see more evidence of a deceleration in services inflation to have confidence in overall inflation returning to 2%.
Transcript
In the first quarter of this year, U.S. economic growth slowed significantly from late 2022, but this was mainly driven by inventory data. Excluding the effects of inventories and net trade, which tend to be volatile quarter to quarter, growth in domestic demand was strong.
Consumer spending on goods was a silver lining in the first quarter. It was particularly evident in auto sales. However, given rising interest rates and higher average selling prices for cars in recent years, I expect that demand for cars will slow going forward.
The labor market also appears remarkably resilient. But I am looking at survey data as a leading indicator of what lies ahead. In these surveys, private sector hiring intentions are coming down, particularly from small businesses. Layoffs also spread beyond the tech sector, although they are not at recessionary levels at this point.
As demand for workers slows, I expect that job vacancies and postings will drop further, leading to a cooling in wage pressures later this year or in early 2024. Overall, though, I do not see any major cracks in the labor market, and I only expect a small uptick in the historically low unemployment rate by the end of 2023.
Turning to inflation, overall measures of consumer prices have fallen quickly along with energy. However, we have seen less improvement in core inflation rates, which exclude the volatile components of food and energy.
Recent data has shown some signs of deceleration in rent inflation, and we care about this because it is a major component of services prices. But we’ll need to see further evidence of a broader deceleration in inflation and prices to have confidence that overall inflation will return to 2%.
That brings us to the Fed. Its inflation target is, of course, 2%. And markets right now are pricing multiple Fed cuts in the second half of the year. But I think that the inflationary environment is such that the Fed will not be in a position to cut interest rates anytime soon. When I look back at 2022, I think of it as the year when the market kept pricing a Fed pause too soon. 2023 so far feels like the year the market is pricing Fed cuts too soon.
When the Fed does eventually move to loosen monetary policy, I think that the elevated inflation risk in the background will prevent it from cutting rates as quickly as it has in past economic cycles.
Looking at the broader picture, the central bank is clearly now fully data dependent. What I mean by this is that policymakers are monitoring indicators other than inflation, such as credit conditions, to look for signs of growth slowing.
IMPORTANT INFORMATION
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.
It is not intended for distribution to retail investors in any jurisdiction.
USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.
© 2023 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.
Blerina Uruçi is the chief U.S. economist in the Fixed Income Division. She contributes to the formulation of investment strategy and supports investment and client development activities throughout T. Rowe Price, specifically focusing on the outlook for the U.S. economy, inflation, and monetary policy. Blerina is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.
