Macroeconomic Background Improving for Stocks

The stock market should continue to recover through month end and very possibly into the summer, as prospects for a soft landing and a downshift in Fed tightening appear to be improving.  

A slowdown is suggested by commodity prices and Unemployment Benefits Claims.  Commodity prices, for the most part, have unwound their Spring surge but remain at high levels.  They would likely be falling much further if the economy were moving into recession.  Similarly, Unemployment Claims so far are not spiking upwards, as would be the case if the economy were in recession.  Initial Claims are up moderately from their April lows and stabilized in the latest week, while Continuing have only just begun to move up.

Evidence of slowing growth and lower commodity prices should convince the Fed to downshift its tightening moves.  Instead of hiking the funds rate by 75 BPs, as in May, it may very well hike by 50 BPs at the July FOMC meeting.  This would put the funds rate at 2.25%.  An additional 75-100 BPs over the year's remaining 3 FOMC meetings would get the rate to the Fed's target of 3.0-3.25%.  This amount of tightening would require further downshifting.

Evidence of a moderation in longer-term inflation expectations supports the idea of a downshifting in monetary policy tightening at this point.  The drop in the University of Michigan's 5-Year Inflation Expectations to 3.1% in the final-June report from the very high 3.3% at mid-month is important.  The high mid-month print helped persuade the Fed to hike by 75 BPs rather than 50 BPs at the May meeting.  Its unwinding should be welcome relief to Fed officials, who expressed concern about a ratcheting up of longer-term inflation expectations.  Indeed, the final Michigan print implies a sub-3.0% average in the second half of June.  The recent flattening in the Treasury yield curve is another piece of evidence that should dampen the Fed's concern about inflation expectations.  

This is a light week for US economic data, but the risk is for further evidence of a slowdown rather than recession.  Consensus looks for small gains in May Durable Goods Orders, although the risk is to the downside.  Consensus also expects declines in May Pending Home Sales and June Conference Board Confidence.  But, the latter is still expected to be at a high level.  The second revision to Q122 Real GDP should be small and hold no surprises.  The Atlanta Fed model's latest estimate of Q222 Real GDP is 0.0% (q/q, saar).  But, there is not yet enough data to make a reliable current-quarter GDP estimate.