Has A Recession Already Begun?

Over the next few weeks, the stock market still has to contend with the risks of soft Q222 corporate earnings and a large rate hike at the July 26-27 FOMC Meeting.  Nevertheless, stocks could be helped by a growing expectation that the Fed will downshift tightening after the July FOMC Meeting. 

Although the market and some Fed officials flirted with the idea of a 100 BP Fed rate hike at the end of the month, a 75 BP hike appears to be the likely outcome -- according to the WSJ.  Macroeconomic evidence supports this smaller extent of policy tightening.  There are mixed signals coming from inflation and real-side data.  And, the possibility that a recession already has begun cannot be ruled out.

The June CPI was high, and the Core could continue to be so for awhile -- as inflation is a lagging indicator and tends to be sticky.  In particular, the CPI calculates housing rent  as a moving average, so it takes time for the latter to settle down from a steep run-up.  But, the June PPI and Import Prices have elements pointing to more subdued inflation pressures ahead.  The underlying Core PPI Ex Trade Services  and Core Intermediate Prices moderated.  The soft June Import Prices show the effects of the strong dollar and weak economies abroad.  Moreover, the decline in the 5-Year Inflation Expectations component of the University of Michigan Consumer Sentiment Survey to 2.8% in mid July put them back to their prior range. It suggests the Fed's anti-inflation intentions are being viewed as credible -- which could prevent inflation from spiraling higher.  

Real-side data are sending divergent signals, as well.  Strength was seen in parts of the Employment Report, Durable Goods Orders and Retail Sales.  But, if the Atlanta Fed model's projection of a decline in Q222 Real GDP is correct, the start of a recession conceivably could be dated in April or May.  Declines in Civilian Employment and Manufacturing Output began then.  They are inputs in the cyclical dating process.  While Payrolls were strong during the quarter, their import was deflated somewhat by a decline in the workweek.  Moreover, benchmark revisions to Payrolls (an estimate of which is due in August) could reduce the recent pace of job gains.   The Conference Board Leading Indicators are expected to fall in this week's report for June.  This would be their third decline in a row -- an old, but not right all the time, rule of thumb pointing to recession.  

Even if Q222 Real GDP did not decline, signs of a developing slowdown are building.  Initial Unemployment Claims are trending up.  Job openings are falling.  And, most commodity prices have unwound their Spring bounce.  A significant slowdown in economic activity, even without a recession, would argue for a downshift in Fed tightening.

This week's US economic data will feature some housing-related data and manufacturing surveys.  Consensus looks for declines in June Existing Home Sales and Housing Permits, but an increase in Housing Starts.  The risk is for a counter-consensus decline in Starts, as well.  Consensus also expects an uptick in the Phil Fed Mfg Index, similar to what was seen in the NY Fed Empire State Mfg Index.  But, consensus sees a dip in the Markit US Mfg PMI.  All the manufacturing surveys so far are not in recession territory.