Global Monthly - US: Cooling goods consumption too late to shift inflation

The US is being particularly hard hit by the Omicron wave. A comparatively sluggish uptake of booster shots has compounded an already low vaccination rate, and as a result, hospitalisations and more importantly ICU occupancy resulting from Omicron infections has actually surpassed that seen in previous waves. This stands in contrast to the experience of many European countries, where rates of ICU admission have been significantly lower than in previous pandemic waves. While any notion of restrictions on activity has become political anathema in the US – despite the enormous pressure on healthcare systems – citizens have nonetheless taken it upon themselves to reduce social contact, with high frequency data showing a clear drop-off in pandemic-sensitive air travel and restaurant dining sectors. All told, activity in these sectors fell by about 10% in the first weeks of January compared to the December average. While case numbers look to be peaking now, the delay to the services recovery – in combination with additional supply-side disruptions – led us to lower our 2022 growth forecast by 0.3pp to 3.8% (see Global View for more).

At the same time, nominal retail sales fell by 2.1% in December, with the real fall likely somewhere nearer to 2.6% given current elevated inflation readings. While volume data has yet to be released, we estimate real retail sales are now running at just 1.5pp above the pre-pandemic trend, a significant decline from the 5-10pp in excess consumption seen for much of 2021, and the smallest gap with trend since February (just prior to the final round of stimulus checks). While a welcome development, given the contribution excess goods consumption has made to the surge in inflation this year, it has likely come too late to shift broader inflationary dynamics, which have since become self-reinforcing via the ultra-tight labour market. In December, wage growth momentum accelerated further, to 6.1% 3m/3m annualised (see chart on p3) while other measures such as the quit rate and vacancies remain historically elevated. Already services – particularly housing – has become a bigger contributor to inflation in recent months, and it is likely that even as goods inflation declines, strong wage growth will fuel a further pick-up in services inflation as the year progresses. The net effect is that inflation should still come down significantly this year, but we expect core inflation to settle at a level well above the Fed’s target, in the 2.5-3% range.

All of this is keeping pressure on the Fed to continue radically pivoting in a more hawkish direction, and we saw further evidence of that in recent weeks, with many officials openly advocating for a March rate hike. The balance sheet is also increasingly seen as a potential tool to tighten policy, should rate hikes alone fail to cool inflationary pressures. The December FOMC minutes signalled a likely quicker unwind of the balance sheet compared to the previous quantitative tightening episode, and comments from hawks such as Mester even hinted that outright sales of Treasuries might be considered (“won’t take anything off the table regarding balance sheet reduction”). Our base case is that, soon after lift-off in March, the Fed will begin allowing the balance sheet to slowly unwind, gradually picking up the pace to $60bn per month. However, given the degree of inflationary pressure, the risk is for the Fed to move even more aggressively.