The Federal Reserve’s key labor costs metric for the first quarter came in hotter than expected Friday, helping to seal the deal on the central bank’s 10th consecutive rate hike in May, while raising the probability of another one in June.
The Employment Cost Index rose 1.2% in the quarter, and the prior quarter’s number was also revised upward to 1.1% from 1.0%, the Labor Department reported. On a year-ago basis, labor costs remained elevated at 4.8%, down slightly from 5.1% previously.
The employment data came out at the same time as the Bureau of Economic Analysis’s report on spending and the PCE price index, a key inflation metric for the Fed.
While monthly inflation slowed to 0.1%, core inflation that excludes food and energy, stayed hot at 0.3% on the month. On a year-ago basis, overall PCE inflation was 4.2%, and core PCE inflation was 4.2%.
The super core component—core services (i.e., housing)—showed a bit of good news, growing only at 0.24%, down from 0.35% in the prior month. That was equivalent to a 4.5% increase in super core prices from a year ago.
Given Friday’s data, in addition to recent data on jobs and growth, we think that the underlying inflation rate will likely remain in the range of 3% to 3.5% through year’s end. And even if some argue that most of the data looks backward and thus the Fed should be proactive in its approach to rate hikes and cuts, such an inflation level should guarantee no rate cut in 2023, barring a significant recession, which we don’t see as a possibility in the next 12 months.
In the same report from the BEA, personal spending stalled in March in both dollar and inflation-adjusted terms. Spending volume on services went up 0.1%, offsetting a 0.4% decline in spending volume on goods.
March’s data on spending should take away some of the strength observed from the GDP report released a day ago, which showed personal consumption growing at a robust 3.7% in the first quarter. All of that growth was from January.
If this trend continues, we should expect spending in the second quarter to stall and even fall further as the spending of dry powder slows.
Facing a potential economic downturn, Americans have begun to curb spending and save more. The saving rate jumped to 5.1% in March from 4.8% earlier, the highest rate since spring 2022.
Income remained the bright spot, fueled by a strong labor market, rising 0.3% on the month. So, in the case that spending continues to stall, personal income and the job market should keep the economy afloat until tipping into a mild recession in the second half of the year, according to our forecast.
The takeaway
Data released Friday suggests there is more work for the Fed to do to tame inflation with at least one more rate hike. Any rate cuts in 2023 should not be in the picture as of now. The economy is slowing down, putting the likelihood of a hard landing in the remainder of the year at 75% in our estimate.
