Warsh And US Economic Data

The stock market is likely to continue to be dominated by developments in the Iran war and corporate earnings this week.   The FOMC Meeting should be a non-event, with policy remaining unchanged.  Fed Chair Powell's news conference will probably have less to do about monetary policy and more to do with his job plans after his term as Fed Chair ends in May.  In the background, this week's slew of US economic data should support stocks, if consensus estimates print.   They would contain good news for growth and inflation, but not enough to change the overall picture.

US economic data should be market important now that the possibility of a Fed rate cut at some point was lifted by the DoJ's dropping its probe of Powell.  It clears the way for Senate approval of Kevin Warsh as the next Fed Chair, who could be more inclined to ease at some point than Powell if the data suggest so.  Besides the possibility that he may respond quickly to softer US economic data, his intention to reduce the Fed's balance sheet substantially by selling longer-dated securities could prompt a Fed rate cut.  The latter would be an offset to the higher longer-term yields stemming from these sales.

To be sure, this week's US economic data are not expected to change the macro background and thus the Fed's intent to keep policy steady.  The data are seen showing solid economic growth and higher-than-targeted inflation.  However, the most important report could be the Q126 Employment Cost Index (ECI).  This is because Warsh has testified that he puts more weight on measures of underlying inflation than headline figures.  And, Labor Costs are a major determinant of underlying inflation.  

The Q126 ECI is expected to show that labor costs are contained.  The Index is expected to rise 0.8% q/q.  While a speedup from the low 0.7% in Q426, it still would be below the 0.9-1.0% increases seen in 6 of the past 9 quarters and the y/y should fall.  A consensus or below-consensus print would likely be viewed favorably by Warsh and the markets.  It should give hope that the recent speedup in price inflation will prove temporary. 

Warsh has testified that a trimmed measure of price inflation is preferable to the standard measures since it would eliminate outliers.  This is a reasonable view, particularly since special factors could boost or lower a handful of CPI components each month.  Also, a trimmed measure could eliminate large relative price changes, either temporary or persistent, that impact the Core CPI but should be ignored by policymakers.  (To be sure, a moving average of the CPI or Core CPI tends to eliminate swings in components that quickly unwind.)  The latest trimmed inflation measures are mixed relative to the official measures (see table).  The Dallas Fed's measure shows the underlying inflation rate much closer to the Fed's 2% target than the headline figure. 

                                                     March Y/Y Percent Change                

Core CPI                                                             2.6%

Cleveland Fed Trimmed Mean CPI                    2.6% 

Core PCE Deflator                                              3.0%

Dallas Fed Trimmed-Mean PCE Deflator           2.3%  

As for other data to be released this week, consensus looks for Q126 Real GDP Growth to be 2.1% (q/q, saar), up from 0.5% in Q425.   The Atlanta Fed model's latest estimate is 1.2%.  However, the model may have missed the full boost to growth this quarter from the re-opening of the federal government after it underestimated the drag from the shutdown in Q425.   The same risk applies to the consensus estimate.  So, a higher-than-consensus print can't be ruled out.   The 2-quarter average of GDP Growth should give a better measure of the underlying pace.

Nevertheless, the bounce-back from the government shutdown could have spurred the economy's momentum.  This could be a factor behind the strength expected in March Consumer Spending and Durable Goods Orders.  Consensus expects March Consumption to jump 0.9% m/m, with about half resulting from higher prices.  The "real" increase would be a decent gain.  Consensus also expects March Durable Goods Orders to climb about 0.5% both for Total and Ex Transportation.  This pace is below the 0.8% m/m Q126 average for Ex Transportation, but is still a solid increase.

This week's inflation-related data should not be a problem for the market.  The March Core PCE Deflator is seen slowing to 0.3% m/m from 0.4% in February.  It would remain above the pace consistent with the Fed's 2% inflation target.  The market, though, would likely discount it as a potentially temporary reflection of higher oil prices and tariffs.  The trimmed  measure may be given more attention.