The Fed's Choice

The stock market should hone in even more on the upcoming May 2-3 FOMC meeting.  A 25 BP rate hike that brings the funds rate target up to the bottom of the Fed's Central Tendency forecast for 2023 is a strong possibility.  But, whether the Fed hints that it could be the last, or at least could be followed by a pause, may be more important for the market.   This week's US economic data could bear on the Fed's choice of message to convey.

Consensus has moved up to an expected slightly above-trend 2.0% (q/q, saar) increase in Q123 Real GDP.   The Atlanta Fed model's latest forecast is somewhat higher at 2.5%.  Any strength in Q123 GDP likely will be dismissed as history.   Nonetheless,  a high GDP print could suggest the potential for growth momentum carrying into Q223.  So, if anything, it would argue for another 25 BP hike.

Fed tightening and payback for the warm winter point to a weaker GDP print for Q223.  The question will be the extent of softening.  Unemployment Claims provide the broadest and most up-to-date measure of the economy.  So far,  Initial Claims have stayed in a relatively high range since mid-March (228-247k), indicating a flattening in the pace of layoffs.  Staying in this range would suggest only a modest slowdown in economic activity.  Continuing Claims, however, jumped in the latest week, suggesting hiring has stalled.  This jump needs to be confirmed in this week's report.  A confirmation -- particularly if they climb steeply again -- would spark more talk of a sharp slowdown, if not near-term recession.  High prints for the Claims data could help persuade Fed officials to choose to hint of a pause in tightening ahead.

This week's inflation data -- Q123 Employment Cost Index (ECI) and March PCE Deflator -- could influence the Fed's choice, as well.   Consensus-like prints would argue against a pause.  Consensus looks for the Core PCE Deflator to rise 0.3% m/m, the same pace as in February.  This pace is too high from the Fed's perspective -- annualized it is 3.7% versus the Fed's 2.0% target.  Consensus also looks for a speedup in the ECI to 1.1% (q/q) from 1.0% in Q422 -- showing that labor costs are speeding up.  But, the ECI looks like it could slow, based on Average Hourly Earnings (AHE) --  see table below.  Also, since ECI is a broader measure of labor costs than AHE, it may pick up cuts in year-end bonus payments.  A slowdown would be a significant difference from the consensus estimate.  It could raise hopes of slower inflation ahead and support the possibility of a pause in Fed tightening after the May FOMC meeting. 

                             (q/q percent change)

                          AHE                        ECI      

Q123                0.8                             na                 

Q422                1.2                            1.0

Q322                1.1                            1.2

Q22                  1.1                            1.3  

Q122                1.3                            1.4