Coming to Grips With Powell's Comments

The stock market may continue to be weighed down this week as it comes to grips with Fed Chair Powell's comments.  He was disappointed in seeing three consecutive months of high inflation prints, ignoring the idiosyncratic parts of the March CPI.   As a result, the Fed's inflation target gets higher priority, requiring the need to delay rate cuts.

By also intending to keep the funds rate steady, the Fed appears to be relying on tighter financial market conditions to fight inflation.  Higher yields, weaker stocks, and a stronger dollar are meant to restrain economic activity, thereby holding down inflation.  Consequently, strong data are bad for the markets (implying more restraint is needed), while weak data are good (implying less restraint is needed) from this perspective.  In this regard, Thursday's release of Q124 Real GDP could present a problem.  The Atlanta Fed model's latest estimate is 2.9%, while consensus is 2.1%.  Both are above the Fed's 1.7-2.0% estimate of longer-run growth. 

Whether a weaker economy is needed may depend on whether inflation slows by itself.  A slowdown in the inflation trend would mean the Fed and markets don't have to restrain economic growth.  Steady Fed policy in the context of moderate economic growth and slowing inflation would again be a positive for stocks.

A slowdown in inflation by itself is conceivable.  The industry-specific reasons for the high CPI in March could ease if not reverse somewhat in coming months.  Housing rent could slow as well, as it catches up to the softening seen in private surveys.  Indeed, there is a chance for a surprise low inflation print this week.  Consensus expects a still-high +0.3% m/m in both Total and Core PCE Deflator for March.  The estimate appears reasonable and would not likely be a positive for the market.  But, a 0.2% print for Core can't be ruled out.

There are already tentative signs that the post-winter bounce in economic activity may be easing.  /1/ Initial Unemployment Claims have stopped falling while Continuing turned up a bit.  If they stay at the latest levels, they would suggest a slowdown in April Payrolls.   /2/ The Phil Fed Leading Index of Capital Spending edged down in April.  This should be seen in Durable Goods Orders within the next few months although this week's release for March may be too early.   /3/ Commodity prices possibly may have peaked.  Besides oil, some of the major commodity price indexes are off their recent highs. 

That Powell continues to push back the timing of rate cuts is not surprising.   Economic forecasts, as well as the theoretical idea that real interest rates will rise as inflation expectations fall, are highly tentative and bound to fail when the markets build in future policy.  Higher stocks, lower long-term yields and weaker dollar stemming from projected Fed rate cuts work to boost economic growth, thereby undermining the forecast.  Perhaps the Fed forecasted rate cuts to placate Congress and the Administration in this Presidential election year.  The idea may have been that promising rates cut in the near future would allow the Fed to hold policy steady through the election without being criticized for keeping policy too tight.   However, the built-in failure of this forward-announcing policy approach risks damaging the Fed's credibility.