This Week's Key US Economic Data Are in the Details

Most of this week's macroeconomic evidence should continue the positive backdrop to the stock market.  The advance report on Q121 Real GDP Growth is expected to be strong, the FOMC should maintain its easy policy stance, and corporate earnings are likely to continue beating expectations.   But, the markets are beginning to focus on the durability of the very strong growth and the potential for higher inflation.  To this point, the details of this week's data may be more important than the headlines.    

High Q121 Real GDP Growth, like the 6.5% (q/q, saar) consensus or 8.3% Atlanta Fed model estimate, will capture the headlines and probably elicit a knee-jerk bounce in stocks.  The important question for the markets, nonetheless, is what evidence the report provides regarding Q221 economic growth.  The internals of the report should confirm solid momentum in Final Sales, with consumption fueled by stimulus payments and the improving jobs market.  The Personal Income Report, released the following day, will show how far March  consumption stands above the Q121 average -- the take-off point for Q221.  But the markets may discount this evidence, believing the boost from the fiscal stimulus is temporary.  So, what may be more important is what the GDP report's internals show regarding the extent to which Nonfarm Inventory Investment has made up the $300 Bn (annualized) net drawdowns over 2020.  Unless it fully makes up for the decline, re-stocking will remain a catalyst for above-trend growth ahead. 

Last week's report showing a decline in Initial Unemployment Claims to 547k argues that economic growth remained strong going into Q221.  The 577k average of the first two weeks of April is well below the near-790k average of both Q420 and Q121.  Further declines would argue that economic growth has not peaked or at least remains above trend.

Although the Fed has downplayed any high inflation print for now, blaming them on temporary bottlenecks and base effects (see my April 11 blog), the markets are not as sanguine.  So, this week's data on the Q121 Employment Cost Index and March Core PCE Deflator are important.  The internals could be important here, as well.

Consensus looks for +0.7% (q/q) in the Q121 ECI.  This report is typically not a market mover, although it is now bears attention as the least affected by compositional shifts among the major measures of labor costs.  Consensus is slightly higher than the 0.6% 2020 average but the same as the 2019 average, not much to be of concern.  But, there is upside risk, given news reports of some large companies offering higher wages in response to labor shortages combined with the possibility of start-of-year hikes.  In addition, sales commissions could be boosted by the surge in retail sales.  These incentives reflect higher productivity and, as a result, are not inflationary.   The ECI excluding sales commissions could be more important than the headline regarding the inflation outlook.  This measure rose 2.5% (Q4/Q4) in 2020 and 2.7% in 2019.

In contrast, there is downside risk to the consensus estimate of a +0.3% m/m in the March Core PCE Deflator, based on the its different composition from the Core CPI (which printed +0.3% m/m).

 

Did Stocks Get Too Bullish on Economic Growth?

The latest decline in longer-term Treasury yields in the face of very strong US economic data suggests the markets have begun to question the sustainability of the economy's recent strength.  Stocks risk pulling back as a result, since they reacted noticeably to last week's strong prints.  A pullback should be modest and temporary, however,  as the stock market's rally should remain supported by above-consensus corporate earnings releases in the next few weeks. 

The extraordinarily strong March US economic data probably overstate the underlying strength of the recovery.  Temporary boosts from weather rebounds and the injection of stimulus funds likely accounted for some of the large gains.  Nevertheless, growth should remain above trend in coming months.

The boost from better weather was clearly seen in March Housing Starts/Permits data.  All the increase in Permits was in the South and Midwest, which had suffered badly from weather in February.  The Midwest and South saw most of the increase in Starts.  Northeast did also.  All three posted declines in February.  Starts in the West fell in March, after they had risen in the prior month.  The February-March average is 1.60 Mn Units.  It is somewhat less than the 1.656 Mn December-January average, so there may be some flattening in trend -- which is close to the level estimated to be the long-run level of demand for housing.

The Mid-April University of Michigan Consumer Sentiment Index also raised questions about the sustainability of the recent surge in economic activity.  The Expectations Component, at 79.7, is well below the 97.2 Current Conditions Component, suggesting people view the recent strength to be somewhat temporary.  

The Unemployment Claims and manufacturing survey data, like the Current Conditions Component, suggest growth is still well above trend in April.  But, the latest w/w drop in Initial Claims, -193k to 576k (a new low for the move down) could have been impacted by the Easter holiday.  So, the low level needs to be confirmed in this week's report.  If they are, it would be solid evidence that growth remains above trend this month.

The Philadelphia Fed and  NY Empire State Mfg Surveys both point to a very high Mfg ISM in April.  Even so, the chip shortage is restraining some manufacturing activity.  For example, while motor vehicle assemblies rose to 9.3 Mn units in March from 8.9 Mn in February, they remained below the 10.7 Mn in January.  But, all this means is that motor vehicle production will strengthen as chips become more available.

Base Effects, Corporate Earnings and Inflation

Over the next few weeks, the stock market should turn its attention increasingly to Q121 corporate earnings.  Macroeconomic evidence supports expectations of strong earnings, such as the consensus estimate of +20% (y/y).   "Base effects," which translate prior year's weakness into current year strength on a y/y basis, also play a role.

Base effects will impact the y/y calculations for inflation in the next few months, as well.  This is because the sequential, or m/m, change in measures like the CPI and PCE Deflator weakened during the pandemic-induced lockdowns.  So, a return to trend-like inflation now results in a pickup in the y/y inflation rate.  Fed Chair Powell has mentioned this effect a number of times, so they should not affect Fed policy.

The question is whether the base-effect boost to the y/y inflation rate will prove to be temporary.  This will depend on the sequential pace of inflation in coming months.  For both the Core CPI and Core PCE Deflator, the y/y will fall back to well below the Fed's 2.0% target by July if the sequential m/m remains weak at +0.1% m/m.  The y/y remains close to the Fed's target through September if the m/m stays at 0.2% and remains above target if the m/m is 0.3%.                     

                                           Core CPI                                Core PCE Deflator
                                        0.1    0.2    0.3                            0.1    0.2    0.3                           
Jan  (a)                            1.4    1.4    1.4                            1.5    1.5    1.5
Feb  (a)                            1.3    1.3    1.3                           1.4    1.4    1.4
Mar                                 1.4    1.5    1.6                            1.6    1.7    1.8
Apr                                 1.9    2.1    2.3                            2.2    2.4    2.6
May                                2.1    2.3    2.7                            2.0    2.4    2.7
Jun                                  1.9    2.0    2.7                            1.8    2.2    2.6   
Jul                                   1.5    1.8    2.5                            1.6    2.1    2.6
Aug                                 1.2    1.8    2.4                            1.4    2.0    2.6
Sep                                  1.1    1.8    2.6                            1.3    2.0    2.7

This week's US economic data includes the March CPI.  Consensus is for +0.2% m/m Core, and in line with some upside risks including higher apparel prices after an early Easter, pass-through of higher oil prices and supply-side bottlenecks.  Other data should be strong, including March Retail Sales and Industrial Production.  Much of their strength would be a weather-related bounce-back from February drops, so to some extent should not be extrapolated ahead.  However, stimulus checks will be credited for a jump in Retail Sales, as well, and their effect could last for several months.  The most interesting of next week's data will be Initial Claims to see if they remain near their elevated levels of the prior two weeks.  If they do, the apparent absence of significant further improvement in the labor market could raise doubts about the magnitude of the economic recovery.

 

The March Emploiyment Report and Q121 Corporate Earnings Outlook

The markets will be digesting and reacting to Friday's blow-out March Employment Report early this week, with the stock market pitting strong growth against higher long-term yields.  Some of the March strength was one-off, reflecting re-openings and a weather bounce.  But, there was still underlying strength.  The solid recovery supports the consensus expectation of a large y/y increase in Q120 corporate earnings.  These expectations and then the releases, themselves, should help sustain the stock market rally.

Arguably, about half of the +916k jump in Payrolls can be explained as one-off -- seen in Construction, Leisure and Hospitality, and State & Local Government Education jobs.  Taking away about 450k from the headline print still leaves an extraordinary increase, nonetheless.  The rebound in the Nonfarm Workweek to a high 34.9 Hours also signals a speedup in business activity.  This week's reports on March Non-Mfg Purchasing Managers Surveys should reaffirm this improvement.  

The inflation-related components of the March Employment Report were benign.   /1/ Average Hourly Earnings fell 0.1% m/m, with half the major sectors down.  Compositional shifts toward lower-paid workers could have contributed to the decline, however.  /2/ While the Unemployment Rate fell 0.2% pt to 6.0% it remains above the old 5.5% estimate of the inflation threshold and well above the current estimate of 4.0-4.5%.  /3/ A 0.1% pt increase in the Labor Force Participation Rate prevented the Unemployment Rate from falling by more.  If the LFP Rate were steady, the UR would have rounded up to 5.9%.  An increase in the LFP Rate provides the economy more room to grow in a non-inflationary way.  

Consensus expects +20% (y/y) in the S&P 500 earnings for Q121.  Most of the macroeconomic evidence suggests a large gain.  Real GDP could have turned positive on a y/y basis in Q121.  And, the rebound in oil prices should lift profits in this industry.   Similarly, the further weakening the dollar increased the dollar value of earnings abroad.  Although the relationship between the Core CPI and Average Hourly Earnings suggests a squeeze on profit margins, this is probably overstated -- the relatively high pace of AHE on a y/y basis reflects compositional shifts away from low-paid workers rather than a significant speedup in labor costs.  The Employment Cost Index (for private sector) shows no speedup over the past 3 years, essentially steady at 2.6% (Q4/Q4).

                                                                                                                                          Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.6                 +1.7                             3.2           2.3               46.2

Q120           -5.0                -16.5                 +2.9                             3.1           2.3               47.2

Q220         -10.6                -53.5                 +5.9                             6.5           1.4               40.1

Q320           -2.8                -27.8                 +1.0                             4.8           1.7               52.4

Q420           -2.4                -25.5                  -1.9                             4.8           1.6               54.6

 

Q121            0.3                 36.7                  -3.0                              4.9           1.3               58.4                                           

         

* Based on the Atlanta Fed Model's latest projection of +6.0% (q/q, saar).

 

Strong US Economic Data Expected This Week -- But Some Caveats

The stock and Treasury markets could clash again this week in the face of strong US economic data.  But, not all considerations support the consensus estimates.  So, there is a chance the stock market rally will survive this week's data prints and the longer-end of the Treasury market will stay in its range.

The markets will have to contend with a string of strong US economic data this week, if the consensus estimates are correct.  Strong prints are expected for March Conference Board Consumer Confidence, ADP Estimate, Chicago PMI, Mfg ISM, Nonfarm Payrolls and Unemployment Rate.  In particular, consensus looks for +655k m/m Payrolls and a 0.2% pt decline in the Unemployment Rate to 6.0%.

While most evidence would seem to support the consensus estimates, there are a couple of caveats.  /1/ All business surveys that so far have reported for March posted an increase.  But, many of them missed the increase in the February Mfg ISM.  So, at least some of their March gains could have been catch-up and thus give an overly positive view for the March Mfg ISM.  Indeed, a widening impact of chip shortages could weigh on the latter.  /2/ The Claims data argue for a speedup in March Payrolls and a decline in the Unemployment Rate.  However, at least some of the job strength could be offset by an increase in the Labor Force in the calculation of the Unemployment Rate.  The Claims data do not say anything directly about Labor Force.  So, the Rate may surprise to the upside relative to the consensus estimate.

An increase in the Labor Force, particularly the Labor Force Participation Rate, would be a positive for stocks and Treasuries.  It would suggest that strong economic growth could be accommodated without putting stress on the labor market -- and thus avoiding higher wage inflation.  This possibility would support corporate profit expectations and make economic growth less of a concern for Treasuries.

The near-term US economic growth outlook is strong, nonetheless -- which could mitigate, if not prevent, month-end/quarter-end selling of stocks.  Besides the additional fiscal stimulus and expanding re-openings, there should be a bounce-back from the bad winter weather in parts of the country.  Inventory re-building could be a catalyst for new orders and production in coming months, as well.  The Claims data improved notably in the latest report.  And, the ECRI Leading Index has made new highs for the year in mid March (see chart below).

ECRI Leading Index (level, weekly)

     

             Jan 1, 2021                     Feb 5            Feb 26           Mar 19                

 

What Did the Fed Do?

The markets are likely to remain focused on Fed policy this week, as Fed Chair Powell testifies to Congress and other Fed officials make speeches.   They are not likely to diverge from the views expressed in last week's FOMC Statement.  There also will be Treasury auctions this week, with the most important perhaps being the 7-year -- which showed weak demand at last month's auction.  The degree of demand this time would bear on whether yields have moved up enough.

The Treasury market so far has clearly not been convinced of the benign Fed outlook of modestly above-trend growth and slight uptick in inflation in the next couple of years, despite a strong recovery from re-opening in 2021 and continuation of very low short-term rates.  It apparently is concerned that inflation will rise faster.  In addition, the markets were hit with Friday's announcement of the Fed's unexpected decision to allow the expiration of an easing of banks' reserve requirements at month end. 

Market commentators focused on the possibility that a renewal of the requirement for banks to hold reserves against deposits and Treasury holdings will force them to sell Treasuries.  But, this implication may not be right from a macro perspective.  The Fed may have to buy Treasuries in order to supply the increased demand by banks for reserves (otherwise short-term rates would rise -- contrary to the Fed's desire).  The more important implication may be that the Fed in effect tightened by increasing the bank reserve requirement.  As market commentators point out, the increased requirement could lead to banks to cut lending (eg, by tightening lending standards).  From this perspective, the Fed did half of an operation twist but one that should be a positive for the longer-end of the curve -- tightening but not by raising short-term rates.  It also should hurt cyclical as well as bank stocks. 

There is irony in curtailing bank lending, particularly if, as reported, Congressional Democrats argued strongly for the Fed to renew the reserve requirement.  By holding back this channel of monetary policy, other channels -- most importantly stocks and longer-term Treasuries -- have to work harder to achieve the Fed's goal of full employment. One result is the need for low short-term rates to continue.  Another is an exacerbation of unequal wealth distribution.  This happened in 2009 when Democrats pushed for tighter restrictions on banks.  

The broader question is whether the Fed is right in its forecast of only a modest increase in inflation over the next couple of years.  Fed officials argue that this is the most likely outcome as long as longer-run inflation expectations remain contained.   So, reports like the University of Michigan 5-Year Inflation Expectations should become more market significant. (This measure is at 2.7%, the high end of its recent 2.5-2.7% range.)   Current inflation prints are less important since they can be impacted by temporary factors. 

The most important determinant of inflation is the pace of labor costs.  Unfortunately, almost all measures of aggregate labor costs have been distorted by large compositional shifts between high- and low-paid workers as a result of the uneven impact of the virus on jobs.  Perhaps the least affected is the Employment Cost Index, since it holds job distribution constant.  The ECI shows no significant acceleration, if any, so far. 

In regard to wage inflation, the most important piece of information in the next couple of weeks could be the March Unemployment Rate.  The markets could view a steady to higher level as taking some upward pressure off wage inflation.   Even Fed Chair Powell admits to an inverse relationship between the Unemployment Rate and Wage Inflation, although he says the relationship between wage and price inflation is not one-for-one.

The currently low inflation rate should be seen in the February Core PCE Deflator in this week's report.  Consensus looks for a modest +0.1% m/m with a steady 1.5% y/y.   Most of this week's other data -- Existing and New Home Sales, Personal Income and Consumption -- are expected to decline, reflecting temporary factors like the bad weather.  The declines should be dismissed.   The most interesting of the real-side data will be Initial Claims to see if they unwind the prior week's difficult-to-explain jump.

 

 

March FOMC Meeting

The markets' focus this week will be on whether the FOMC responds in any way to the recent market volatility and growth/inflation concerns.  There are a number of ways it can.  But, it is also conceivable the FOMC won't do anything, particularly since the markets appeared to begin stabilizing last week.  The markets may very well quickly shift their focus back to evidence on the extent to which economic growth is speeding up in response to re-openings and fiscal stimulus once the Meeting is out of the way.  This week's US economic data, indeed, risk dampening these expectations.

The FOMC could decide to respond to the recent market concerns by changing policy.  It could decide to increase purchases of longer-term Treasuries, just like the ECB did last week.  Or, it could do an operation twist, lifting short-term rates as well as increasing longer-term purchases.  

There is a potential problem with increasing purchases of longer-term Treasuries, however.  The additional monetary stimulus could exacerbate the growth/inflation fears in the Treasury market.  So, the increased purchases could backfire and result in higher yields.  An operation twist would presumably prevent this problem.  But, it's not clear the Fed would move now to tighten the short-end of the curve, as current core inflation remains soft. 

Instead of a policy change, the Fed could tweak the FOMC Statement to promise a quick response to future inflation, if needed.  This could be done in the Statement or by Fed Chair Powell in his post-meeting news conference.  The prior meeting's Statement said:

 "The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments." 

Theses sentences would seem to cover the possibility the Fed would respond quickly to an unwanted speedup in inflation.  But, it could be tweaked to increase emphasis on a response to inflation pressures.  Also, the sentences appear in the last paragraph of the Statement.  It could be moved to a more prominent position, but that could be construed as a more aggressive signal than officials want to send.

The markets will also likely pay attention to updates to the Fed's Central Tendency forecasts.  The Treasury market could react negatively if officials boost the growth/inflation outlook without changing the expected Fed Funds Rate trajectory.  But, this reaction could be muted if Powell emphasizes downside risks to the outlook or if the growth speedup is seen as temporary, as is likely. 

The Fed's Central Tendencies will likely show a much stronger Real GDP trajectory, particularly for 2021, as the new fiscal stimulus is built in.  But, Powell is still likely to emphasize downside risks to the outlook stemming from the virus and its more-contagious strains, as did the Fed staff at the January FOMC Meeting.  As a result, the Central Tendencies could show a 2021 speedup in GDP Growth followed by more subdued growth in the following few  years.  The Central Tendency for Inflation will probably be little changed, as it already built in a modest speedup over the 2021-23 period.  For 2021, the PCE Deflator is expected to be up 1.7-1.8% (Q4/Q4).  In January, it was up 1.5% (y/y).  The combination of only a temporary speedup in GDP Growth and modest acceleration in inflation could temper market concerns of an overly easy monetary policy.

This week's US economic data could temper near-term growth expectations.  February Retail Sales, both Total and Ex Auto, are seen falling by 0.5% m/m.  The risk is to the downside.  Besides the drag from bad weather, particularly in Texas, a pullback often follows a strong advance such as January's.  Note, though, that the best measure of Retail Sales will be Ex Auto/Ex Gasoline.  Gasoline Sales will reflect higher prices.  There is downside risk to the consensus estimate of +0.6% m/m in February Industrial Production.  Chips shortages were still curtailing motor vehicle production that month.  Also, Total Hours Worked in Manufacturing fell 0.3-0.4% m/m.  Consensus looks for little change in February Housing Starts and a decline in Permits.  Bad weather represents downside risk to this forecast.