A Leap Day Data Roundup

Happy Leap Day! The financial world celebrated the only way it knows how to celebrate anything, with a fresh batch of economic data. Here is a quick look, plus a wee bonus.

Eurozone Inflation Isn’t a Wage-Price Spiral

Flash inflation readings for Germany and France hit the wires today, and headlines’ reaction echoed the narrative about US inflation over the past several months: Improvement is encouraging, but “sticky” service prices show high wages are still a problem.

If you simply knew this and hadn’t seen the numbers, we think there is a fair chance you would think the inflation rates in question are still lofty. And yet, headline German CPI clocked in at 2.7% y/y (down from January’s 3.1%), with services inflation holding steady at 3.4%.^[i] France’s figures were similarly improved, with headline inflation slowing from 3.4% y/y to 3.1% and services prices from 3.2% to 3.1%.^[ii] Both are slower than US services prices, which we discuss more below, and they look high only in comparison to the 2010s’ perpetually below-average inflation … which many argued were problematic back then.

Anyway, none of this is an attempt to predict the ECB’s next move, but we don’t agree with all those who portray this as a policy conundrum. People see services prices as “sticky” because they can’t apply the standard retail goods pricing model, which would presume consumer prices slow and perhaps even fall as suppliers’ costs go down. Yet people still cling to the notion consumer prices always and everywhere depend on input prices. And since wages are one easy-to-see services cost input, many presume services prices rise in tandem with wages. So with wages rising in Germany and France, folks presume there is something of a vicious cycle at work.

That is the theory. Reality differs, showing across time and countries wages follow prices, not the other way around, as employers have to pay more to compete for workers as living costs rise. Milton Friedman made the definitive rhetorical case for this in the late 1960s, and data since have proven him right. Those who argue wages push services inflation ignore this, along with the fact businesses could easily cut other costs to support higher wages without raising prices anew. They could add automation to improve productivity. Or they could be taking advantage of lower energy costs. Or or or! It is the sort of math and planning that businesses do all the time.

So where people see growing wages as call for gloom, we see bricks in the wall of worry. Far from being inflation fuel, higher wages restore some of the purchasing power people across the developed world lost in 2022, which should contribute to improving economic data. Not a massive tailwind, but when it is so underappreciated, it doesn’t need to be to continue delivering a positive surprise.

America’s Targeted Inflation Gauge

The US also got in on the inflation fun courtesy of January’s personal consumption expenditures (PCE) report, which includes consumer spending data as well as the Fed’s preferred inflation gauge. The common thread running through them: the divide between goods and services.

On the PCE inflation front, headline inflation eased from 2.6% y/y in December to 2.4%, now less than half a percentage point away from the Fed’s 2.0% target.^[iii] (Yes, the Fed targets headline PCE not core, despite oodles of reporting to the contrary.) Underlying the improvement, goods prices are now in deflation. Yes, DE-flation, as in prices falling, down -0.5% y/y (versus December’s flat reading).^[iv] Energy prices play a role here, as they were down -4.9% y/y, but the so-called control group (consumption excluding food, autos and auto fuel) slipped -0.3% y/y. We don’t expect prices to keep falling to levels anywhere close to the prepandemic era, but this is a good sign that the inflation hump is now firmly in the rearview.

We say that even though PCE services inflation remains elevated at 3.9% y/y, matching December’s rate.^[v] This is largely because PCE—like CPI and unlike the eurozone—includes owner’s equivalent rent, which is a hypothetical cost that no one actually pays. This is predominantly why housing services prices rose 6.1% y/y, continuing the modest downtrend but still a major outlier versus other services prices. Beyond that, the messaging on eurozone CPI applies here, too—wages follow services prices, not the other way around, so this isn’t evidence that wage growth is making inflation more entrenched than it would otherwise have been.

On the spending front, the divide between goods and services is equally apparent but has a different cause. Goods spending fell -1.1% m/m, flipping from December’s 0.9% rise, while services spending matched December’s 0.4% growth rate.^[vi] The disconnect’s big culprit is auto sales, which fell -7.4% m/m, extending its long run as a swing factor.^[vii] But goods sales were also negative across most categories, albeit at a slower rate. We suspect, though we can’t be sure, that this may be partly a function of post-pandemic seasonal adjustment difficulties. On an unadjusted basis, January sales normally fall from December’s holiday-fueled levels. Seasonal adjustments account for this, but they do so using the past few years’ trends. Holiday-related data have been wonky the past few years due to lockdowns and reopenings, which messed with the normal seasonal patterns, and statisticians have admitted to having a heck of a time trying to compensate.

At any rate, since most services are essential—and therefore less prone to short swings—stable services spending seems like a more accurate readthrough. Spending rose across most services categories, with only recreational and “other” services in the red. Transport and food service were up, along with housing, health care and financial services. So it seems to us that people continued going about their bustling normal business in January, starting the economic year on strong footing.

A Parting Word on Revised US GDP

And now the wee bonus: revised Q4 US GDP data, which hit the wires Wednesday. The BEA revised headline growth down a smidge from 3.3% annualized to 3.2%, but this is actually a pretty good revision.[viii] Inventories’ impact was revised down from a 0.07 percentage point (ppt) contribution to a -0.27 ppt detraction, turning the slight restocking into a slight drawdown.^[ix] Now, inventories are always open to interpretation, though based on Q4 earnings calls, it seems reasonable to say the drawdown happened because demand exceeded supply, not because businesses are still getting lean. More importantly, though, the fact that inventories got a -0.34 ppt downward revision—while the headline growth rate inched down only -0.1 ppt—tells us other categories got revised higher. And that is indeed what happened, with consumer spending now estimated at 3.0% annualized growth, up from the 2.8% preliminary reading.^[x]

This is all old news to stocks, which have long since moved on from what happened last September through December. But it is more evidence, however incremental, that the private sector is doing better than anticipated, showing some surprise power persists even as investors fathom that all last year’s recession predictions didn’t come true.