Stock Rally Ahead?

Three macro themes should dominate the stock market in the next few weeks:  /1/ evidence of weaker economic growth,  /2/ moderating inflation, and /3/ uncertainty about the state of the banking sector.   Stocks should rally into the Spring if upcoming evidence points to economic slowdown rather than recession, lower inflation, and an easing of the banking crisis.  There is a good chance that it will.

The most important evidence regarding the economy will be the March Employment Report.  The Claims data, as well as other evidence, point to another slowdown in Payrolls.  And, an increase in the Unemployment Rate can't be ruled out.  But, the Report is unlikely to signal recession.  Layoffs have stayed at a low level so far this year, seen by the flat trend in Initial Claims.  Although re-hiring has pulled back -- Continuing Claims have moved up somewhat in the past two months --  a recession should entail a more severe move in hiring.  

Curiously, the Fed's Central Tendency Real GDP Forecast suggests flat to negative economic growth over the last 3 quarters of 2023, if the Atlanta Fed model's 3.2% Q123 estimate is correct.  The Central Tendency Forecast is for 0.0-0.8% for 2023 (Q4/Q4).  Together, the model's Q123 estimate and the Central Tendency imply -1.1% q/q to 0.0% in Real GDP Growth in each of the next 3 quarters -- that is, a recession.  To be sure, if payback for the warm winter begins to show up in March, as is likely, then the Atlanta Fed model's estimate of Q123 GDP could be revised down, implying somewhat stronger growth for the rest of the year if the Central Tendency Forecast is correct.

Slower economic growth, in any case, should help lower inflation.  Early evidence for the March CPI includes gasoline prices.  Although they are up at the pump so far in March, their increase is less than seasonal.  So, they should decline fairly sharply on a seasonally adjusted basis in the CPI.  Apparel prices, too, may slow significantly after two months of large increases.  The early Easter could help, as apparel discounting is typical ahead of the holiday.  And, the recent decline in oil prices could show up in lower airfares.  In contrast, Used Car Prices could move up, based on the recent uptrend at the wholesale level.  The big question remains whether Owners' Equivalent Rent will begin to soften noticeably.

Recent comments by Fed Chair Powell and Treasury Secretary Yellen seem to reveal a great deal of uncertainty about the extent of the banking problems.  Although Powell called the overall banking system sound in his post-FOMC news conference, the Fed's newly established lending facility (Bank Term Funding Program) suggests the risk is wider than a few isolated cases.  Note that many banks apparently have shifted their borrowing from the Fed's discount window to this new facility, as the latter may have lower borrowing costs than the window.  So, the increase in the new facility's loans should not be viewed as a measure of the banking system's fragility.  Yellen appears to be trying to prevent bank runs without making the bank business risk free.  All these somewhat contradictory statements and actions could continue to exacerbate market fears.  If the banking crisis winds down, however, the stock market should move up, particularly if an economic slowdown, not recession, becomes the dominating theme -- and especially if inflation falls.