The U.S. economy appears to have lost steam to start the year as omicron takes center stage and inflation takes a bite out of purchasing power. Since our real-time economic report on Dec. 10, COVID-19 infection rates have increased manifold, discouraging social activities, with mobility weakening through Jan. 10. However, with 62% of the U.S. population fully vaccinated and omicron apparently less virulent than past variants, the impact on mobility has been much more modest than in summer 2021 and fall 2020.

Consumer confidence readings disappointed in January, reflecting inflation concerns and virus fears. University of Michigan consumer sentiment dropped to 68.8 in the preliminary January reading, marginally above its 10-year low of 67.4 from November. The Ipsos-Forbes Advisor U.S. Consumer Confidence Tracker released on Jan. 13, still at pre-omicron levels, is 10% below its 62.4 high from the week of June 10.

A strong jobs market--with initial jobless claims at a multidecade low, the unemployment rate under 4%, and job openings still at record highs--supports consumer spending this year, though higher prices will crimp purchasing power. Retail sales fell by 1.9% in December after strong gains through August, with holiday shopping pulled forward on worries that supply-chain disruptions would leave shelves empty in November.

Fortunately, supply constraints have eased in recent months, suggesting the light at the end of the tunnel is in sight. Nonetheless, it remains to be seen whether new lockdowns across the globe may reignite supply disruptions later in January, with China, based on its "zero-COVID" policy, possibly starting the trend.

Meanwhile, amid heightened inflationary pressures, the Federal Reserve has turned more hawkish, as its December minutes show. We expect "liftoff" to start in May with the first of three rate hikes this year. Depending on the data, balance-sheet normalization will likely start in early 2023.

Record-High New Cases Are Discouraging Mobility

Even with 62% of the population fully vaccinated and 23% having received booster shots, new COVID-19 cases in the U.S. shot up to a record high of over 740,000 per day (seven-day moving average) as of Jan. 11, over 7.5 times the number on Dec. 1 (see chart 1). Daily deaths have nearly doubled since Dec. 1 to 1,700 as of Jan. 11, though they are 39% below the Dec. 22, 2020, peak. Omicron reportedly causes less severe illness than other variants, particularly for fully vaccinated people.

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The surge in new cases has noticeably discouraged mobility for retail and recreation. According to Google Community Trends data, after mobility climbed back to pre-pandemic levels leading up to Christmas, it deteriorated to 21% below pre-pandemic levels on Jan. 7. New York now has the lowest mobility among major states we track, at 33% below the 2019 average (see chart 3).

Leisure activity has also dropped in the past two weeks. With growing concerns about omicron, people are avoiding crowded places. The national average of seated diners dropped to 28% below the pre-pandemic level as of Jan. 10--hitting the lowest reading since April--with New York, Illinois, California, and Georgia showing the sharpest declines (see chart 4). The national average is much higher than in April 2020, when it dropped to 100% below the pre-pandemic level.

Meanwhile, held back by restricted business travel and cautious households, the hotel occupancy rate, now at 54.3%, has continued to trend down from its 71.4% peak in July 2021 (see chart 5). With much less business and leisure travel, air traffic has stayed around 18% below the 2019 level in the past two weeks (see chart 6).

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Consumer Confidence Weakens On Surging Inflation And Omicron

Consumer sentiment weakened in January on spiraling inflation, supply bottlenecks, and the fast-spreading omicron variant. The University of Michigan's Consumer Sentiment Index fell to 68.8 in January, near its 10-year low of 67.4 from November. Current conditions fell to a 10-year low of 73.2, while expectations fell 2.4 points to 65.5 in January, closer to the eight-year low of 63.5 in November (see chart 7). While the biweekly Ipsos-Forbes Advisor U.S. Consumer Confidence Tracker ticked up on Jan. 13 to 56.7, it's 10% below its June high (see chart 8).

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Supported by the hot jobs market, shoppers were able to buy items with higher prices through early January. The Johnson Redbook Same-Store Sales Index stayed buoyant, increasing by over 14% year over year for the week of Jan. 7, though this likely reflected higher prices for items bought (see chart 9). This followed a 1.9% month-over-month drop in the Census' December retail sales--a 2.3% drop excluding autos--largely because of the earlier holiday shopping season.

With consumers' willingness and opportunities to socialize diminishing, however, we may see the nesting instinct return, with more spending on home-related items and less on leisure activities in the coming weeks.

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Mortgage Applications Are Resilient Amid Swelling Home Prices

Home demand remains relatively healthy at the start of 2022, driving home prices higher amid tight housing supply. News that the Fed plans to raise rates as soon as March (we expect the first hike in May) also brought people off the sidelines to buy homes. The Weekly Mortgage Application Purchase Index from the Mortgage Bankers Assn., at 283 as of Jan. 7, has trended down since November 2021 but is near its 2021 average of 282 (see chart 10).

November 2021's single-family new-home sales were up by 12.4% from October to 744,000 units at a seasonally adjusted annual rate. Existing home sales meanwhile went up 1.9% to 6.46 million units at a seasonally adjusted annual rate, hitting a 10-month high.

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The hot U.S. housing market is reflected in the NAHB/Wells Fargo Housing Market Index, which reached 84 in December, its highest level since February last year. Housing starts rebounded strongly in November as well, to 1.679 million units, 11.8% higher than the October level, helping to explain the recent pickup in lumber prices.

Lumber prices jumped to $1,205/1000 board feet on Jan. 11--three times higher than the Sept. 15 low (see chart 11), though they are still 29% below the May 2021 high. The recent upswing in lumber prices possibly stems from the lingering effects of floods in British Columbia, one of the leading lumber manufacturers. Meanwhile, the U.S. Department of Commerce's announcement of plans to double tariffs on softwood lumber from Canada to 17.9% from 8.99% in 2022 also explains the recent gains in lumber prices.

Amid the surging lumber prices, the median price of a new single-family home rose to $416,900 in November--18.8% more expensive than in the previous month--according to the National Assn. of Home Builders. The median price for an existing home was 13.9% higher than in October.

Supply-Chain Woes Are Abating

While ongoing supply bottlenecks continue to pose a risk, real-time data suggests easing across the supply chain. Though well above pre-pandemic levels, shipping and capacity measures have moderated some. While the Taiwan Purchasing Managers' Indices for new orders and backlog orders climbed higher and away from their 50-point neutral rate in December, both are well below their spring highs, suggesting some alleviation of production pressure (see chart 12). With Taiwan the leader in semiconductor production, this may signal some moderation in bottlenecks later this year.

On the home front, most U.S. Purchasing Managers' Index readings now sit closer to the 50-point neutral rate (see chart 13). The price subindex fell to 68.2 in December: well above its 50-point mark, indicating lofty prices, but well below its 92.1 peak in June, indicating some easing in price pressures.

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Commodity prices were mixed in recent weeks, though well above pre-pandemic levels. Gasoline prices seem to have stabilized, falling a tad in December and early January from November levels. Retail gasoline prices edged down to $3.30/barrel for the week ended Jan. 10 from $3.40/barrel in November, though this was still near a seven-year high (see chart 14).

Meanwhile, the Industrial Metal Price Index rose to $1,660.80 on Jan. 11, 53% higher than its 2019 average of $1,085.47 (see chart 15). The recent uptick in part owes to omicron-related production delays, as well as expectations for increased infrastructure demand. Raw steel capacity utilization dipped by 2 percentage points to 80.9% on Jan. 5, just above the index's 2019 average of 80.7 (see chart 16). At the same time, the Baltic Exchange Dry Index continues to trend lower: At 2151 on Jan. 11, it is 62% below its record high of 5650 on Oct. 7 (see chart 17).

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That said, China's "zero-COVID" policy forced several manufacturing units to close their operations in December, sending another warning signal to the global supply chain. Closure of factories may spread to other manufacturing hubs in the country and abroad, possibly reigniting the supply-chain disruptions that have only started to unwind.

Inflation Expectations Remain Elevated

Overall, price pressures for several commodities we track, as well as long-term inflation expectations, edged down from multiyear highs in late November, but prices are still uncomfortably high. The University of Michigan five-to-10-year inflation expectations measure rose to an 11-year high of 3.1% in January from 2.9% in December. We now expect the Federal Reserve to speed up tapering to reach "zero" by March 2022. We see the Fed raising rates three times in 2022, with the first rate hike in May.

After a 0.5% jump in the Consumer Price Index (CPI) in December, year-over-year CPI growth hit 7.1%, a 40-year high. Long-term inflation expectations, as measured by the 10-year forward inflation rate, were 2.54% on Jan. 11, after reaching a 16-year high of 2.76% on Nov. 15 (see chart 18). The five-year forward inflation rate inched lower to 2.2% on Jan. 11 from 2.4% on Nov. 18.

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