Stock Recovery Continuing, But Risk of Aggressive Fed Looms

The stock market recovery was not derailed by a hawkish shift in Fed Chair Powell's message last week.  The possibility of a 50 BP rate hike is still too far ahead to dominate the market.  But the threat could weigh on stocks after the bulk of Q122 corporate earnings are reported and the May 3-4 FOMC  meeting approaches -- and especially since the March CPI, due April 12, will reflect the surge in oil prices.  However, this week's key US economic data, such as the March Mfg ISM and Employment Report (both due on Friday), risk pulling back from their strong February prints.  They still should be strong enough to argue for continuing Fed tightening.  But, they might dampen the risk of a 50 BP hike and, along with strong corporate earnings, sustain the stock market recovery for a while longer.

Consensus looks for a steady 58.6 March Mfg ISM.  This would keep the Index at a slightly lower level than the 60.7 2021 average -- still historically high but a bit more moderate than last year.  The evidence is mixed, with the Empire State Mfg ISM pointing to a decline while the Phil Fed Mfg Index to an increase.  But, the Phil Fed Index could have just been catching up to the increase registered by the Mfg ISM in February -- which it had missed.  The Empire State correctly predicted the direction of Mfg ISM in each of the past two months. 

The consensus estimates for March Nonfarm Payrolls (+475k m/m versus 676k in February) and Unemployment Rate (3.7% versus 3.8%) are consistent with the Unemployment Claims data.  While job growth is expected to slow somewhat, it still would be above trend -- as seen by the expected decline in the Unemployment Rate.  The most important part of the Report could be Average Hourly Earnings, after its flat print in February.  There is no evidence.  Consensus looks for a speedup to +0.4% m/m.  This would put it back to the pace that predominated between June and November 2021 and below the 0.5-0.6% increases seen in December and January.  Along with the flat February print, it could be viewed as confirming that the December-January speedups were aberrations and that wage inflation is contained so far.  This could spark a relief bounce in stocks and Treasuries.

Consensus-like prints of this week's key data would not guarantee a 50 BP hike by the Fed in May.  But, they would not rule it out either.  There are reasons why a more aggressive Fed tightening may be appropriate.   /1/ While the run-up in oil prices should be viewed as a relative price change, its impact on other prices is so pervasive that it gives the impression of higher overall inflation.  This could feed into increased wage demands -- and thus a wage-price spiral.  /2/ With the Unemployment Rate so low and job vacancies so high, demand for labor is too strong and has to be reduced to avoid wage/price inflation.  The sooner this happens, the less chance of inflation getting out of control.  /3/ A more aggressive Fed would likely undercut speculative demand in commodities.  Commodity prices could fall somewhat, although it seems that fundamental reasons are behind their recent run-up.