The U.S. economy appears to have taken a breather in April after the burst of activity in March. Economic data (for April) that national statistical agencies have released in the last two weeks were, on net, weaker than anticipated (see table 1). Still, according to the Atlanta Fed's GDP tracker, growth in the second quarter is running at a 10.1% annualized pace (versus our 11.3% forecast).

Consumer prices surprised on the upside (0.8% month over month), which boosted the headline Consumer Price Index (CPI) inflation rate to 4.2% year over year, the sharpest increase since 2008. Core inflation rose to 3%. The Personal Consumption Expenditures (PCE) inflation, which is the Fed's preferred consumer price inflation measure, has been about 30 basis point below CPI inflation, so we wouldn't be surprised to see the headline and core PCE inflation logging in high-3s and high-2s, respectively, when they come out next week (see table 2 for our monthly data forecasts).

Components that had seen the biggest disruptions during the pandemic--travel-related areas like airline fares, car rentals, and hotels--also saw the largest price hikes for the month. This comes amid a confluence of demand resurgence and supply-side bottlenecks, higher energy costs, and rising wage pressures. Many of these pandemic-related price swings are likely to be transitory but, consistent with our forecast, will stick around long enough to push inflation above 2% in the months ahead (compared with the 1.5% PCE inflation average the last 10 years).

While we fully expect the current price pressures associated with reopening and supply chains to ease and some of the large price increases to reverse in the next 12 months, we recognize the risk that it may take longer. Producers can be reluctant to let go of their shortage-induced pricing power right away. Wage increases for new workers may have knock-on effects for existing workers' wage increases next year. If the pandemic caused firms to restructure their supply chains, bottlenecks could then last longer than currently anticipated as these supply chains are rebuilt. There are also asymmetric price effects from cost shocks to consider: Prices go up very quickly but often tend to come down more slowly, as consumers slowly learn that the bottlenecks have gone away.

Consumers Are Concerned About Higher Inflation

Preliminary consumer sentiment fell to 82.8 in May, from 88.3 last month, according to University of Michigan. Despite the improving jobs market and vaccination rollouts, together with generous government transfer payments in March and April, households see worsening financial conditions led by higher inflation, which is likely to erode real income. Gas prices at the pump have been rising steadily since last December, and after settling at $2.85 in early April, climbed even higher to $3 (a psychological mark) earlier this month when Colonial Pipeline was hit by a cyberattack.

Chart 1

The 12-month (short-term) price inflation expectation climbed to 4.6% from 3.4% and ties April and March 2011 for the firmest since August 2008, versus the 2.1% expansion low in April 2020. The 5-10 year gauge (long-term) jumped to 3.1%--the highest since March 2011--from 2.7% and versus the all-time low of 2.2% in December 2019.

But a one-time tumble doesn't change the fact that households are more confident about the present and future economic conditions than they were last spring, when the sentiment index fell to 71.8 in April from the precrisis level of 101. We expect the Conference Board's Consumer Confidence Index to pull back to 118 from 121.7 in April.

Homebuilder Activities Eased But From A High Level

Both housing starts and housing completions were down, but forward-looking building permits were nearly unchanged. A pullback in homebuilding activity in April was expected given the outsize gain of 20% starts in March.

Housing starts fell to 1.57 million, declining sharply by 9.5% from March. This was led by a tumble in single-family starts, which dropped by 13.4% from the previous month. Housing completions fell as well, registering a decline of 4.4%. Single-family completions were barely changed at 1.05 million, 0.1% above the March level. Despite the contraction in groundbreaking activities, 1.76 million annualized building permits were issued in April, 0.3% above the March level. April housing permits were 9% above the pre-crisis figure (February 2020). Meanwhile, housing starts went slightly below their pre-crisis level of 1.59 million.

Homebuilders, however, remained optimistic about the housing market. The National Association of Home Builders (NAHB) homebuilder index remained at 83, unchanged from April. The well-above-50 reading indicates homebuilders' strong confidence in sales of single-family homes at present and in the next six months. Homebuilders continue to point to increasingly expensive construction materials, especially lumber, as a negative to sentiments. NAHB reported that a sharp rise in input costs is adding roughly $36,000 to the average price of a new single-family home.

On the housing demand side, mortgage applications for the week ended May 14 are 1.2% above a week earlier but almost unchanged compared with the level four weeks ago, despite a decline in the mortgage rate since the start of April. The 30-year fixed mortgage rate declined to 2.94% on May 13 from 3.18% on April 1. The U.S. median age of millennials around 33 (the prime household formation and first-time homebuying age) and the lower borrowing costs support demand conditions, but higher home prices are likely starting to discourage homebuyers who are increasingly finding themselves stretched for down payments and competing with investors and cash buyers. Affordability challenges are likely to become more binding in the months ahead, thus acting as a headwind to limit the upward trajectory in homebuilding.

We had expected housing starts to gradually cool from the 1.7 million-1.8 million pace to about 1.5 million from the second quarter on. Although one month of data doesn't make a trend, April numbers make us comfortable with our forecast.

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Supply Constraints Slow Industrial Output Growth In April

Industrial activity--manufacturing, mining, and utilities combined--picked up for the second straight month in April, up 0.7%, after a brief winter snapback in February, following a 2.4% gain in March. With April's expansion, industrial output was 2.7% below its pre-pandemic level.

Mining output rose 0.7%, after net downward revisions in earlier months. Manufacturing output rose 0.4% in April, compared with the 3.2% rise in March. Nondurable goods output picked up 1.3%, offsetting a 0.4% drop in durable goods output, especially motor vehicles, which plummeted 4.3% in April.

Semiconductor supply remains the headwind for the auto sector. Global shortages of semiconductors for auto parts are currently forcing auto manufacturers to slash their production. For instance, capacity utilization dropped to 69.4% in April from 72.5% in March. This was the lowest capacity utilization on record--excluding last year's pandemic-related plunge (March to June).

Persistent semiconductor demand-supply mismatch is further worsening conditions for auto manufacturers as they are stressed to procure adequate and timely supply to fulfill customers' demand. The average lead time of semiconductors has jumped significantly, to more than 105 days in April from 80 days in December (as per Electronic Component Industry Association's April survey). This also reflects what we saw in April month's payroll data, as jobs in the auto sector fell by 27,000.

That said, computer and electronic output notably was largely insulated from the pandemic, continued to post strong growth, and was 3% higher than its pre-crisis level. The sector's capacity utilization also was at a nearly four-year peak in April, reflecting the sector's strength on U.S. industrial activities.

Meanwhile, overall capacity utilization inched up again, to 74.87% in April, but remained 40 basis points below the January high of 75.3% (the highest reading since the pandemic began last March).

We expect manufacturing activity to remain upbeat. The current manufacturing business conditions in the Philadelphia Fed district stayed solid, though they softened from a 50-year high in April (50.2), to 31.5 in May. Shipments and new orders slowed but were still elevated. Importantly, price indicators of the survey point to a persistent surge to a nearly 40-year high. Input price rose to its highest level, 76.8, since March 1980, while prices received jumped to 41 (highest since May 1981), indicating that firms started to pass on the input price pressure to consumers. The survey also points toward the jump in delivery time by firms, largely due to supply-related issues. On the other hand, the unfilled orders index climbed to its highest level since March 1973.

Concurrently, another survey from the New York Fed points toward healthy manufacturing activity, signaling a persistent strong expansion--though sentiment ticked down slightly in May. Strong global demand coupled with a pickup in business investment and fiscal stimulus will drive U.S. manufacturing activity throughout this year. However, both the surveys indicated input price and selling price pressures may have longer staying power than previously thought. Surveys suggested firms expect the own prices they face to rise faster than inflation for U.S. consumers.

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Table 1

Table 2