Last Week In The US: Worrying Trend In Prices

This past week was a busy week, and despite stronger-than-expected retail sales in April, the general tone of data releases was rather gloomy. Such data, especially prices, are in fact consistent with the Fed not slowing down the monthly pace of security purchases, something to keep in mind when the minutes of the latest FOMC meeting will be released on Wednesday.

The week began on a very positive footing, with retail sales reporting to have gained 0.1% in April. The strength was widespread, as only few retailers saw their sales declining over the month: gas stations (-4.7%), food and beverages (-0.8%) and health and personal care (-0.1%). Sales of everything else were up, from building materials (+1.5) and cars (+1.0%) to clothing (+1.2%). Excluding volatile items (cars), price-sensitive sectors (gas) and building materials (which are part of residential investment and not private consumption in US national accounts), retail sales were up a very solid 0.5% in April. In short, the soft patch did not spread beyond March. On a 3-month annualised basis, retail sales were up 4% in April, with the core index up 4.2%. Such data are consistent with a steady GDP growth over the first half of 2013.

However, news from the business sector was not as supportive, with industrial production down by 0.5% in April. The decline was mainly due to falling activity in electric and gas utilities, and manufacturing production was actually up by 0.2%. Smoothed over three months, the deceleration is however unquestionable: in February manufacturing production was growing an annualised 7.7%, a pace cut to 3.4% in April. Prospects are uncertain as orders and surveys send conflicting messages.

Excluding highly volatile data for transport and defence industries, manufacturing new orders accelerated a bit in March, up an annualised 7.5% (after 3.4% in February and 6.6% in December). On the other hand, regional surveys are pointing to further deterioration in activity. The manufacturing surveys conducted by the Fed of New York and Philadelphia in their respective districts, highlight another deterioration in sentiment. Our NEM Index (calculated from these survey-data in a way that allows direct comparisons with the ISM index) lost 0.6 point to 49.4 in May, with inventories bringing the only positive contribution. Such a development is not positive as inventories may have risen because of weak demand, which would announce further contraction in production in the months ahead. Still, regional surveys proved mixed leading indicators as lately. In April, even if it was down, the ISM index was not as bad as announced by the NEM Index, remaining above the 50-threshold with the new orders component increasing.

The most concerning news of the week came from the trend in prices. Far from highlighting a build-up of upward pressures on prices, data are signalling too mark a slowdown in inflation. The recent deceleration in inflation could be a cause for concern. Until recently, the slower rate of price increases was obvious when measured with the deflator for private consumption expenditures but more questionable when measured by the consumer price index. With March and April CPI reports, this changed. The index for non-food non-energy consumer prices has been decelerating from 2.1% in 2012 and 1.9% in Q1 2013 to 1.7% in April. Using a narrower measure (excluding fruit, vegetables, gasoline, fuel oil, natural gas, homeowner equivalent rent of primary residence, inter-city transportation and tobacco products, following the preferred measure of the Bank of Canada), the trend is even more pronounced. This “augmented”-core CPI was up by a limited 0.6% y/y in April, following 1.0% in Q1 2013 and 1.7% in 2012. This is the slowest pace of growth since end-2010.

It is difficult to explain this deceleration in prices, even though a limited pace of increase in prices is not surprising. For price pressures to appear either production costs have to accelerate or demand has to be larger than supply. As for costs, the main one is labour. On that front, even if conditions are gradually improving, the unemployment rate remains high enough to prevent wages from accelerating. Additionally, even if it slowed, labour productivity remains robust. In Q1 2013, unit labour costs were indeed up a very limited 0.5% (quarterly annualised rate). As for supply, over-capacities remain large as shown by the still large negative output gap. This lack of price pressure is confirmed by the trend in prices at early stage of processing. Non-petroleum import prices are down on a year-on-year basis for the second month in a row, a trend experienced since the second half of 2012 by core PPI indices for intermediate goods and raw materials.

If such a trend in prices were to be confirmed in the months ahead, inflation would turn from not being a constraint for accommodative monetary policy to a reason for monetary policy to be accommodative.

BY Alexandra ESTIOT