Is A Bullish Window For Stocks Closed?

The window for a stock market bounce may have been closed by Fed Chair Powell's hawkish speech last week, in which he did not rule out the need for a recession to tame inflation.  But, maybe not.

To be sure, an expectation of a Fed-induced recession may continue to weigh on stocks.  The only questions are when will it begin and by how much does the Fed have to tighten to bring one on.  But, the answer to the first question is not soon.  So far, none of the US economic data indicates a recession is close, let alone here.  The market, though, may continue to treat them as old news to be ignored, as it did last week.  But, with upcoming US economic data expected to remain non-recessionary (see below), the market may decide to take a pause in its fear of recession.

A test could be seen with another Powell speech on Tuesday and the release of the May FOMC Meeting Minutes on Wednesday. Both are unlikely to contain anything new, but should underscore the Fed's serious intent to fight inflation.  A bullish surprise (and perhaps warranted) would be if Powell tries to dampen the fear of recession, for example by saying that while a recession may be needed to lower inflation that is not the Fed's baseline forecast.

Part of the problem for the market is the uncertainty regarding how much monetary policy tightening will be needed to achieve the Fed's inflation target.  With the risk that the already announced 50 BP hikes at the next two FOMC Meetings will not be the end of tightening, the burden for fighting inflation falls to the markets just in case the Fed actions are insufficient or too gradual to achieve the goal.

Powell has said the Fed does not target the stock market, but views it as one of the major channels through which monetary policy impacts the economy.  There are three major channels -- stocks, Treasury yields and the dollar.   As long as Treasury yields and the dollar continue to remain off their highs, the stock market has to bear the most weight in the fight against inflation.

With Powell saying the Fed may tolerate a recession to achieve its 2% inflation target, evidence of slower economic growth may not be enough to send an "all clear" signal.  The Fed may need to see an actual softening in inflation and its determinants -- wage rates and commodity prices -- to pause on rate hikes.  Waiting for signs of slowing inflation could lead to recession.  A soft landing in the economy was achieved in the past when the Fed was quick to pause on signs of slowdown.  A Fed-induced recession occurred when rates were hiked into the downturn. 

This week's US economic data are expected to show a strong consumer and manufacturing sector in April.  Personal Income and Consumption are seen up 0.6-0.7% m/m.  And, Durable Goods Orders are expected to climb 0.6%.  The April Core PCE Deflator is seen rising 0.3% m/m, the same as in March but still above the Fed's target.  It is reasonable to expect the PCE Deflator to be below the 0.6% Core CPI, both because of differences in composition and in their measurement of airfares.