Near-Term Inflation Shows No Signs of Slowing, but New Home Construction Appears Resilient

Key Takeaways:

• The minutes from the Federal Open Market Committee’s (FOMC) January 25-26 meeting showed that “most participants suggested that a faster pace of increases in the target range for the federal funds rate than in the post-2015 period would likely be warranted” due to a stronger growth outlook, higher inflation, and a tighter labor market. Further, most participants stated that if inflation does not slow as they expect, it would be appropriate to tighten faster than currently anticipated. Regarding the balance sheet, “a number of participants” stated it would likely be appropriate to begin reducing the size of the balance sheet “sometime later this year.”
• The Producer Price Index (PPI) for final demand of goods and services rose 1.0 percent in January, the largest monthly gain since May, according to the Bureau of Labor Statistics (BLS). On an annual basis, prices rose 9.7 percent, a deceleration of one-tenth from the prior two months. The gain was driven partially by a 2.5 percent jump in energy costs and a 1.6 percent increase in food costs. Final demand for services rose 0.7 percent for the second consecutive month and 7.7 percent on an annual basis, a deceleration of four-tenths from December. Core PPI (less food, energy, and trade services) increased 0.9 percent over the month, the fastest gain since January 2021, and 6.9 percent over the year.
• Retail sales and food services increased 3.8 percent in January, the strongest monthly gain since March 2021, more than recovering from a downwardly revised 2.5 percent drop in December, according to the Census Bureau. Sales at motor vehicle and parts dealers were up 5.7 percent and online store sales jumped 14.5 percent. Sales at building materials, garden equipment, and supply dealers were up 4.1 percent, their largest monthly gain in a year. Sales at food services and drinking places, likely affected by the Omicron variant, fell 0.9 percent after a 0.6 percent decline in December.
• Industrial production, a gauge of output in the manufacturing, utility, and mining sectors, rose 1.4 percent in January, according to the Federal Reserve Board. The gain was driven mostly by a 9.9 percent jump in utilities output due to the transition from unseasonably warm weather in December to colder-than-usual weather in January, but mining output was also up 1.0 percent and manufacturing output increased 0.2 percent.
• The National Association of Home Builders/Wells Fargo Housing Market Index declined 1 point to 82 in February, its fifth consecutive month at or above 80. The index for single-family sales in the present was up 1 point to 90, while the index for single-family sales in the next six months declined 2 points to 80. The traffic of prospective buyers declined 4 points to 65, which is 17 points higher than in February 2019. According to the press release, despite strong buyer demand, the index declined because “production disruptions are so severe that many builders are waiting months to receive cabinets, garage doors, countertops and appliances.”
• Housing starts declined 4.1 percent in January to a seasonally adjusted annualized rate (SAAR) of 1.6 million units. Single-family starts were down 5.6 percent to a SAAR of 1.1 million, while multifamily starts fell 0.8 to a SAAR of 522,000, though this was the only two-month streak of a SAAR greater than 500,000 since before COVID. Single-family permits were up 6.8 percent to a SAAR of 1.2 million, the highest level since January 2021, while multifamily permits declined 8.3 percent to a SAAR of 694,000.

Forecast Impact:

The acceleration in the core PPI to its largest monthly gain in a year again illustrates the broad-based inflationary pressures facing the economy. In theory, a higher PPI will feed into consumer prices, though this reading alone does not significantly alter our already upwardly revised CPI forecast. Still, it’s further evidence that inflation is unlikely to slow dramatically in the near-term. The minutes from the January FOMC meeting, which, notably, was held before either the latest CPI or PPI prints were released, were noticeably less hawkish than market expectations, which had shown as many as seven rate hikes priced in by the end of the year before the minutes were released. Our current forecast conducted prior to the minutes release is for a 50-basis point hike in March and two additional 25-basis point hikes in May and June before pausing until later in the year.

Despite headwinds from inflation, retail sales surged in January after a disappointing holiday shopping season. However, we believe this report is being impacted by a seasonal adjustment factor that has not fully captured an adjusted holiday shopping season, as January 2021 was also particularly strong (+7.2 percent) after a weak December 2020 (-0.7 percent). January 2022’s report will likely lead to a modest upgrade in our near-term personal consumption forecast, but due to this seasonal anomaly, the upgrade will likely be smaller than the January report would otherwise suggest. More positively, manufacturing production did not appear to be as heavily impacted by Omicron-related worker absenteeism as feared and is likely to be even stronger in coming months.

New home construction was in line with our expectations and appears resilient thus far in light of rising mortgage rates with single-family permits rising. Although January data likely does not reflect the full impact of recent mortgage rate increases, consistent with the strong NAHB survey, we see this initial strength in construction permits as a sign that demand for new homes remains strong given the lack of existing inventory available for sale. Actual housing starts pulled back, but this was in line with our expectations and likely due to temporary factors, such as weather and COVID-related absenteeism. We therefore anticipate a rebound in starts in the coming months more in line with permits, as new COVID cases have since plummeted and weather has become more normal.

Nathaniel Drake
Economic and Strategic Research Group
February 18, 2022

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae's Economic and Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current, or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management..