The U.S. economy continues to decelerate in January as omicron slows economic activity and inflation takes a bite out of purchasing power. Since our real-time economic report on Jan. 14, new COVID-19 cases have moderated though are still at extremely high levels. Although it's still a workers' market, initial unemployment benefit applications and absenteeism picked up since late December, weighing on productivity and economic activity this quarter. Fortunately, real-time mobility and economic indicators we track appear to have stabilized at their recent low levels.

While our measures of long-term inflation expectations moderated slightly, they remain remain close to their multiyear highs reached in late November. High prices have crippled consumer purchasing power and weighed on consumer confidence in January. With long-term inflation expectation indicators around a decade high, the Fed has reason to be concerned that inflation expectations have proven "persistent." We expect at least three rate hikes this year, with the first in March. Five more rate hikes are in our forecast through 2024. This leaves the U.S. now bearing the impact from continued high prices, or the cure--higher interest rates later on.

New COVID-19 Cases Moderate As Mobility Slows

COVID-19 cases in the U.S. moderated to a still-high 731,000 per day (seven-day moving average) on Jan. 24, near the record high of over 802,000 on Jan. 15 and over 8.5x the Dec. 1 rate. Daily deaths climbed to 2,188 as of Jan. 24, over twice Dec. 1 though 29% below the Dec. 22, 2020, peak (see chart 1). Omicron reportedly causes less severe illness than other variants, particularly for fully vaccinated people. As of Jan. 24, 63.7% of the population are fully vaccinated, 76.3% have at least one dose, and 25.7% have received booster shots (versus 60.6%, 71.4%, and 14.4%, respectively, on Dec. 1). The omicron variant is already in retreat nationwide, according to White House Chief Medical Adviser Dr. Anthony Fauci. If cases continue to subside, the economic impact from omicron will likely be transitory.

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While the extremely high caseload has noticeably discouraged mobility for retail and recreation, the indicators we track appear to have stabilized at their recent low levels. According to Google Community Trends data, mobility in the U.S. held at 19% below pre-pandemic levels on Jan. 18 from its recent low of -21 on Jan. 7. New York still has the lowest mobility among major states we track, at 31% below the 2019 average (see chart 3). The national average of seated diners improved modestly, up 3.5% from our Jan. 14 report, to 24.5% below the pre-pandemic level as of Jan. 23 (see chart 4) and much higher than in April 2020, which dropped to 100% below the pre-pandemic level.

Meanwhile, held back by restricted business travel and cautious households, the hotel occupancy rate, now at 48.8%, has continued to decline from its 71.4% peak in July 2021 (see chart 5). Not surprisingly, air traffic drifted down by 6.2% since our last report to around 24.5% below the 2019 level (see chart 6). This remains significantly above April 2020, when air traffic fell by nearly 90%.

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Economic Activity Moderates On High Prices

U.S. advanced real GDP posted a 6.9% growth rate in the fourth quarter, on healthy consumer spending and substantial inventory accumulation, as businesses play catch up with final demand. Real GDP reached a 37-year high of 5.7% in 2021. The GDP chain price index surged to a 6.9% rate in the fourth quarter from 6.0% the quarter before, the highest pace since the 8.0% rate in third-quarter 1981. Excluding food and fuel, the core rate climbed to 4.9%, its highest since third-quarter 1983, from 4.6% in the third quarter.

In other words, economic output in current prices has far surpassed the precrisis growth rate. But when adjusted for inflation, GDP is still below its pre-pandemic trend as those dollars are not worth as much as before the crisis.

The New York Fed's Weekly Economic Index (WEI), an index of real economic activity using high-frequency data, scaled to align with the four-quarter GDP growth rate, was 6.3% the week of Dec. 25, indicating that GDP for that quarter would be 6.3% higher than a year ago (see chart 7). (Fourth-quarter 2021 GDP over fourth-quarter 2020 GDP was 5.5%, according to the Bureau of Economic Analysis.) The WEI has since moderated to a still-healthy 5.1% as of the Jan. 22 week, higher than our December forecast of 4.7% for first-quarter 2022 over first-quarter 2021.

It is very likely that these first-quarter GDP figures will dip lower. Based on the Census Household Pulse Survey, more than 8.7 million people didn't work in late December/early January because they had COVID-19 or needed to take care of someone who did, pointing to lost productivity and economic activity. Assuming absenteeism continues into the first quarter, one can expect further weakness in productivity and economic activity measures.

Long-term inflation expectations edged down from multiyear highs in late November, while prices are still uncomfortably high (see chart 8). With long-term inflation expectation indicators advancing to a decade high, the Fed has reason to be concerned that inflation expectations have proven "persistent."

While the Fed will likely be sensitive to the flattening yield curve, on concerns of unintended consequences, current inflation pressures indicate that more rate increases from the Fed this tightening cycle are a real possibility. Depending on the data, balance-sheet normalization will likely start in early 2023, with chances of an earlier start.

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Higher Prices Continue To Weigh On Consumer Confidence

On extremely high prices at the checkout denting wallets, consumer confidence measures fell further this month. The Conference Board's January consumer confidence indicator fell by 1.4 points to 113.8 in January, joining the drop in the University of Michigan sentiment to a 10-year low in January (see chart 9). The Ipsos-Forbes Advisor U.S. Consumer Confidence Biweekly Tracker also fell, by 4.4 points on Jan. 27 to 52.3 (Jan. 13 was 56.7), 7.8 points below its pre-pandemic high in March 2020 and well below its 2021 high of 62.4 in June (see chart 10).

A strong jobs market--with initial jobless claims falling to 260,000 in the Jan. 22 week (near its 52-year low of 188,000 in the Dec. 4 week), the unemployment rate under 4%, and job openings still at record highs--supports consumer spending this year (see chart 11). Although, higher prices will crimp purchasing power as real wage gains remain in negative territory.

The Johnson Redbook Same-Store Sales Index stayed buoyant the week of Jan. 14, increasing by over 18% year over year, though this likely reflected higher prices for items bought (see chart 12). The index remains well above pre-COVID-19 levels as consumer demand remained strong, helped by healthy balance sheets. Cumulative average household savings edged down through November but remain more than $2.5 trillion over their 2019 average, suggesting spending activity will continue through 2022. Acknowledging the damage higher prices did to their pricing power over the holidays, consumers will likely be less forgiving of higher prices this year and will look for deals or trade down when available.

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A Pickup In Housing Activity Lifts Lumber Prices

The mortgage applications purchase index held at around 300. While 16% off its Jan. 15 high of 348, it has risen since dipping to 247.50 in the July 30 week (see chart 13). New home sales help explain the recent pickup in lumber prices. Lumber futures prices, at $1,144 per 1,000 board feet on Jan. 21, are down from recent highs but remain elevated on a still-hot housing market, despite continued supply chain constraints and higher tariffs on Canadian softwood lumber (see chart 14). They are 32% below the May 2021 highs.

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Inflation Has Eased Somewhat But Remains Extremely High

U.S. inflation, as measured by the Fed's preferred inflation index, the core Personal Consumption Expenditures (PCE) Price Index, climbed to 4.9% on a year-over-year basis in December, up from November's core PCE inflation rate of 4.7%. Real-time pricing data suggests that inflation may have moderated in January, though at still extremely high rates.

High-frequency pricing data moderated slightly since our Jan. 14 report, though its remains near 2021 highs. The industrial metal price index ticked higher since our Jan. 14 report, on the back of limited supply and high demand spurred by the recovery, reaching a record high of $1,710.52 on Jan. 21 (see chart 15). The bipartisan infrastructure package helped keep prices high. As of Jan. 24, the metal price index is 55% above its 2019 average. Raw steel capacity picked up through Jan. 19 and is now 3.1% above its 2019 average though is 2.5% below its high of 85.3 the week of Oct. 20 (see chart 16).

Gasoline prices, at $3.32 the week of Jan. 24, are 9 cents lower than their seven-year high of $3.41 the week of Nov. 8 (see chart 17). The Baltic exchange dry index has drifted down further through Jan. 24 (see chart 18). At 1,391, it's now above the 2019 average of 1,344. The Baltic dry index is tied to trade in commodities such as coal, iron ore, and grain--so more closely linked to China, Brazil, and India.

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