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January economic data challenges soft landing narrative

The growing economic consensus has hit a bump in the road.

Over the past several months a string of stronger-than-expected data had many investors embracing a possible soft landing, in which inflation would fall to the Federal Reserve's 2% goal without a severe economic downturn.

Recent data over the past week has challenged that narrative. January inflation reports from the Consumer Price Index (CPI) and Producer Price Index (PPI) showed prices increased more than economists projected in the last month. And the January retail sales report showed sales dropped by more than economists had expected. In other words, neither inflation nor consumer strength improved.

To some, one month's prints could be points of concern, but not necessarily game changers.

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"Let's not get amped up when you get one month of CPI that was higher than what you expected," Chicago Fed President Austan Goolsbee said during a question-and-answer session hosted by the Council on Foreign Relations in New York on Wednesday. "It is totally clear that inflation is coming down."

While Goolsbee may have a point that one print might not change a trend, the recent string of January data is notable because it's largely the first chunk of data to challenge the soft landing narrative since Federal Reserve Chair Jerome Powell hinted the US economy may be headed to the ideal outcome during the December Fed meeting.

"The data is stacking up against investors in a way that's making people more nervous," SoFi head of investment strategy Liz Young told Yahoo Finance Live.

Prior to the readings in the past week, the data hadn't worked against investors. Fourth quarter economic growth had come in higher than expected. The January jobs report shocked economists. And the December retail sales print came in better than anticipated, all while wage increases continued to provide a positive outlook for consumer spending and inflation continued to moderate.

After this week though, economists are cutting their projections for first quarter gross domestic product (GDP), a popular economic growth measure. Goldman Sachs has shifted its forecast from 2.9% annualized growth in the first quarter entering the week down to 2.3%. The Atlanta Fed's GDP tracker moved down to 2.9% from a 3.4% projection on Feb. 8. Not auspicious for the economic growth component of a soft landing.

The data is also moving projections for Personal Consumption Expenditures (PCE), the Fed's preferred inflation gauge, ahead of its release later this month. Goldman now projects core PCE, which excludes the volatile food and energy categories, increased 0.43% in January, an increase from its prior forecast of 0.35%. Bank of America's economics team also sees a reading near 0.4%.

Notably, this would bring the six- and three-month annualized rates, which had been celebrated recently as tracking below the Fed's 2% target, back above the 2% level. Not auspicious for the second component of a soft landing.

"While January data are often noisy, the inflation data do suggest that disinflation took two steps back in January," Bank of America US economists Stephen Juneau and Michael Gapen wrote in a note to clients on Friday.

Juneau and Gapen wrote that the January inflation data vindicates the Fed's "wait-and-see approach" to cutting interest rates, and that they agree with the new market consensus that the first interest rate cut will come in June rather than March or May.

This marks a stark shift in investor sentiment on Fed cuts. Investors are now pricing in a roughly 35% chance the first cut comes in May, per the CME FedWatch Tool. A month ago, investors had placed a 97% chance that the first cut would come by the end of the May meeting.

With the Fed rate cut question mostly answered for now, the looming question remains whether the twin inauspicious data points of inflation and consumer strength have upended hopes for a soft landing.

Gapen noted in a weekly economic roundup that it's still too early to tell.

"Our (perhaps unsatisfying) take is that investors should remain in wait-and-see mode," he wrote.

"The surprises in jobs, inflation, retail sales, and [industrial production] were all probably a combination of signal and noise. ... we need to see a few more weeks' worth of data before drawing strong conclusions on the trajectory of the economy."

Consumers, for their part, are still saying they're doing great.

Federal Reserve Board Chair Jerome Powell speaks during a news conference about the Federal Reserve's monetary policy at the Federal Reserve, Wednesday, Jan. 31, 2024, in Washington. (AP Photo/Alex Brandon)
Federal Reserve Board Chair Jerome Powell speaks during a news conference about the Federal Reserve's monetary policy at the Federal Reserve, Wednesday, Jan. 31, 2024, in Washington. (Alex Brandon/AP Photo) (ASSOCIATED PRESS)

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

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