Relief After The FOMC Meeting?

The stock market may find some relief from the outcome of the FOMC Meeting, but this could depend on the latter's message.   The likely 50 BP rate hike and start of Fed balance sheet reduction would be as expected.  So would an expectation for additional aggressive tightening ahead.  What could be important is if the Fed emphasizes its desire for a "soft landing." 

Recent comments by Fed officials reveal 3 targets -- /1/ bringing down inflation to about 2% (annualized), /2/ achieving non-inflationary economic growth, and /3/ raising the Fed funds rate to a neutral 2.5% level.  The third goal is subservient to the first two.  The Fed could take its time raising the funds rate to 2.5% if inflation and growth move toward their targets.

The anti-inflation target is now the most important.  And, this will be seen by emphasizing the need for aggressive, front-loaded monetary policy tightening in the FOMC Statement or in Fed Chair Powell's post-meeting news conference.  But, this is well known and a major reason for the stock market plunge already seen.  The new information will be the extent to which the economic growth target is defended.  A desire to achieve a "soft landing" -- even if acknowledging the possibility of recession -- would suggest the Fed will pull back from tightening aggressively in the face of weaker economic data.  This relatively pro-growth stance could spur a relief rally in stocks.

The problem, however, is that the Fed may have to overshoot its growth target to the downside in order to achieve its inflation target.  The unemployment rate may need to move up to 5.5% to bring inflation down by a couple of percentage points.  But, this possibility will probably not be mentioned, if only for political reasons.  Also, such a weakening in labor market conditions might not be necessary if supply constraints ease up in the near future.  And, the already-stronger dollar should ease inflation pressures coming from import prices.

This week's key US economic data are not expected to be weak, however.  The April Mfg ISM is seen rising to 57.6 from 57.1, consistent with some other surveys.  It would remain below the 57.8 Q122 average, however, suggesting the manufacturing sector's growth has slowed a bit.  Consensus sees a solid 380k m/m increase in April Nonfarm Payrolls, versus +431k in March.  The Unemployment Rate is expected to dip to 3.5% from 3.6% and Average Hourly Earnings (AHE)  to climb 0.4% m/m, in line with the trend seen since June 2021.  Note that some evidence suggests a speedup in Payrolls from the March pace but a steady Unemployment Rate.  There is no evidence, unfortunately, for what is likely the most important part of the Employment Report -- AHE.  A lower-than-consensus print would add to evidence that inflation may be peaking.  A slower pace of AHE is needed to bring down inflation.  AHE averaged 0.2% m/m before the pandemic when inflation was low. 

It is not clear how the stock market would react to near-consensus prints for this week's key US economic data.  Real-side strength would underscore the Fed's intent to tighten aggressively ahead.  But, it also would suggest the economy could handle further increases in interest rates.   On balance, the market's reaction could be muted if Average Hourly Earnings doesn't surprise significantly. 

Even if the "official" data don't signal a sharp weakening in growth, there are early signs that a slowdown may  be in progress.  Many commodity prices are off their peaks.  Trucking rates are said to have fallen.  And, most housing data have softened.  Besides fewer sales, anecdotal evidence suggests that re-sale home prices have begun to fall in some areas.  The one exception could be the motor vehicle sector, where the chip shortage restraints may be ending.  But, a return to normal production should be accompanied by lower vehicle prices.  Note that job growth could be more of a lagging indicator than in the past, given both the need to fill the backlog of past orders and to bring headcount back to pre-pandemic levels.  This may explain why the Unemployment Claims data have not made a significant upturn but appear to be only stabilizing.  All this suggests it may take several months before market talk of a noticeable slowdown becomes pronounced.

While Q122 Real GDP fell 1.4% (q/q, saar), it may reflect a measurement problem.  A surge in imports more than offset increased demand, which doesn't fit well with employment and hours worked data.  It is possible there was a timing mismatch in the measurement of imports and demand -- either between Q421 and Q122 or between Q122 and Q222.