The Weekly Bottom Line

Our summary of recent economic events and what to expect in the weeks ahead

Date Published: January 14, 2022


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  • Equity markets saw further losses this week, following more hawkish messaging from the Fed. Between Powell and Brainard’s confirmation hearings and other Fed speakers, the signals for a March rate hike are flashing loud and clear.
  • December’s inflation data supported the case for a rate hike, with headline inflation reaching 7% year-on-year (y/y). Core inflation also surprised to the upside, and is now up 5.5% y/y – the highest reading in 30 years. 
  • Retail sales showed a loss of momentum to end the year, as inflation erodes consumer purchasing power. Consumer spending is looking weaker in both the fourth quarter of 2021 and the first quarter of 2022 relative to our latest forecast. 

 U.S. - Eyeing Inflation Like a Hawk

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Chart 1: Goods Prices Boost Inflation Near 40-Year High shows the year-on-year change in the consumer price index for goods and services starting in December 2019. It shows that after turning briefly negative early in the pandemic, that goods inflation has surged to 12% year-on-year. Services inflation, which was running around 3% pre-pandemic, has picked up to 4% as of December, far lower than goods inflation.

Equity markets experienced further losses this week, following more hawkish language from Fed officials that signaled rate hikes could kickoff as early as March. The S&P500 has fallen just over 3% from the beginning of the year. Treasury yields continue to march higher as markets adjust their expectation for monetary policy.

Looking at the recent inflation data, the case for rate hikes is clear. Headline CPI ended the year up 7% year-on-year (y/y), the fastest pace since 1982. In December, the month-on-month pace of inflation cooled slightly to 0.5%, as energy prices were a drag on the headline for the first time since April. But, core inflation was even hotter, up 0.6% m/m, driven by strong increases in shelter inflation and another jump up in used vehicle prices. While those items were the biggest contributors, prices were up strongly for a host of goods and services, continuing a trend of broadening price pressures that has been evident since October – the same month that Fed Chair Powell changed his tune on whether the run up in inflation is transitory. 

Accelerating goods prices take much of the blame for inflation’s 40-year record high (Chart 1). You have to go back to 1980 to see goods prices rising 12% in one year. Goods prices should cool over the coming year as production, inhibited by the pandemic and global input shortages, begins to normalize. But, just as it does, service price growth looks to accelerate. Services prices were up 4% year-on-year in 2021, an acceleration from a 3% pace immediately prior to the pandemic, but not out of line with past periods of economic strength. This is likely to move even higher in 2022, keeping pressure on the Fed to tighten policy.

Chart 2: Retail Sales in Real Terms Peaked in April shows the level of U.S. retail sales in real and nominal terms from December 2019 to December 2021. Sales are indexed to 2019=100. It shows that after a plunge early in the pandemic sales recovered rapidly through to early 2021, but peaked in real terms in April 2021. Real retail sales have trailed off since, while nominal sales have plateaued.

The impact of elevated inflation is already evident in retail sales. Retail sales surged in the spring as a third round of stimulus payments from Washington hit Americans’ bank accounts. Nominal sales have plateaued, in part as consumption shifts away from goods, which dominate retail sales, and towards services. However, when you compare to sales adjusted for overall inflation, you see how price growth has increasingly eroded consumer purchasing power (Chart 2). Given that goods prices are up more than services, the picture is even more dire.

Any way you slice it, December’s retail sales data showed that consumer spending lost momentum towards the end of the year. Our December forecast projected real personal consumption expenditure growth around 6% in the fourth quarter. The data released since suggests that it is going to be closer to 4%. It also provides a soft starting point for the first quarter, where spending is likely to slow to 2% as consumer caution on Omicron weighs on close-contact services.

Inflation is also cutting into wage growth, something that has not gone unnoticed by Fed officials. At his Senate confirmation hearing, Fed Chair Jay Powell delivered his most hawkish messaging on inflation yet. Fed Governor Lael Brainard, who is the nominee for Vice Chair of the FOMC to succeed Richard Clarida, echoed his remarks, mentioning that workers are worried about how far their paychecks would stretch. Other Fed officials who spoke this week similarly signaled that interest rates are forthcoming, likely beginning as early as March.       

Leslie Preston, Senior Economist | 416-983-7053