The softer data in manufacturing activities, construction spending and consumer sentiment at the beginning of the year should alleviate some of the recent concerns regarding the rebound in inflation.
The manufacturing sector, as indicated by the ISM manufacturing index, has been in contraction mode for more than a year now, suggesting that demand for manufactured goods will not exert significant pressure on goods inflation in the near future. The index fell to 47.8 from 49.1 previously.
Additionally, consumer sentiment fell in February for the first time in three months but remained at an encouraging level compared to last year. The overall sentiment index stood at 76.9, down from 79.6.
Read more of RSM’s insights on manufacturing and the middle market.
We are not concerned about the softer data or the unusual spike in inflation in the first two months of the year, given the seasonal fluctuations at play.
Looking at all recent data over a longer time horizon, we think that it seems more likely that the economy is cooling down from a robust second half of last year rather than accelerating. This scenario is more consistent with a soft landing, which we anticipate will solidify around mid-year.
When inflation is expected to reach 2% while growth remains near 2% by midyear, we believe the Federal Reserve should lower interest rates sooner rather than later to maintain the balance between inflation and growth.
By then, the Fed should adopt a forward-looking approach rather than lagging behind to claim victory once the targets are met. The work is never finished for the Fed, even when the economy has safely landed. The central bank must anticipate how to foster sustainable growth.
As inflation continues to stabilize, lowering interest rates does not imply that financial conditions are not restrictive enough to control inflation. Given the level of well-anchored inflation expectations, real interest rates should remain positive throughout the process of rate cuts in 2024 and beyond.
Inside the data
Construction spending fell 0.2%, marking the first drop in a year. Most of the decline came from non-residential building, which was down 0.4% for the month. However, manufacturing spending on new construction remained robust, growing 2.1% in January.
It will take months, and even years, for the new jobs in newly built factories to become operational. Currently, job gains in the manufacturing sector appear to be under significant pressure, according to the ISM data. Employment contracted again in February, dropping to 45.9 from 47.1.
Prices paid were less heated for the month, as the ISM price index edged down to 52.5 from 52.9. New orders also declined sharply, falling to 49.2 from 52.5.
