Will the FOMC Tilt The Risks?

The stock market will continue to be impacted by developments in the Iran war this week, with the announced agreement to end the war a positive.  In addition, the market will focus on this week's FOMC Meeting -- the first when the new Chair, Kevin Warsh, will preside.  A key question is whether he convinces the Committee not to include language in the Statement suggesting the risks in the outlook have tilted toward higher inflation and thus to tightening.  Powell had said there was some discussion about doing so at the prior FOMC Meeting.  An unchanged tilt in the outlook risks in the FOMC Statement would likely be a positive for the stock market.

The latest evidence supports a case not to tilt the risks:

The subdued 0.2% m/m Core CPI in May resulted from fairly widespread soft prints.  More than half of the major components posted price changes of 0.2% or less.  So, the modest increase in Core was an accurate depiction of the overall inflation situation.  (The high May PPI, in contrast, was boosted by just a handful of components.)  To be sure, the Core CPI's y/y rose to 2.9% from 2.8% in April.  However, the uptick appears to be caused by a small boost from y/y shifts in seasonality.  The y/y of the seasonally adjusted Core was steady at 2.8%.   

Although higher energy prices continued to boost the Total CPI in May, the decline in oil prices in June points to a more subdued Total in coming months.  Food Prices may be stabilizing, as well.  They rose 0.2% m/m in May, with Food At Home rising only 0.1%.   

An impediment to achieving the Fed's 2% target for inflation is the stickiness in housing rent, particularly the heavily weighted Owner's Equivalent Rent (OER).  It's been running well above 2% (3.3% y/y in May).  This means that other components of the CPI would need to rise by 1.0% or less to achieve the 2% target, unless OER slows sharply.  The economy may need to weaken significantly for such a broad softening in inflation to happen.

The Fed knows this consequence, which is why Powell always pointed to the Core PCE Deflator Excluding Shelter as a better way to measure inflation.  In May, the Core CPI Excluding Shelter rose 0.1%.  Its y/y was 2.4%.  Warsh's favorite inflation measure -- the Trimmed PCE Deflator -- presumably includes OER, but it rose 2.3% on both a 6-month and 12-month basis in April. 

Evidence on labor costs offers a reason to base policy on the low pace of these measures. Labor Costs rose by just over 3.0% (y/y) according to all the major measures.  This pace should be consistent with about 2.0% price inflation, taking account of productivity gains.  

It is questionable whether OER -- which accounts for a quarter of the Total CPI and about a third of Core -- should be included in a policy target.  This is because nobody pays it!  It's an imputed rent, measuring what homeowners would pay if they paid rent.  Moreover, if they did pay rent, they would be paying it to themselves.  It's used in the CPI because it was meant to be an improvement over the prior method of measuring the price of "housing services" to homeowners -- basing it on the mortgage rate and home price.  This prior method had its own problems.  

Regarding the labor market, the Unemployment Claims are beginning to show some softening.  Both Initial and Continuing Claims have inched up in the past few weeks. 

The Meeting will have updates to the Fed's Central Tendency Forecasts.  There could be an upward adjustment to Real GDP Growth, but the other parts should be little if any changed from the March forecasts:   

                                                Fed Central Tendency Forecasts 

                (Q4/Q4% change except for Unemployment which is the level in Q426) 

                                                      2026              Latest  Actual         

 Real GDP                                  2.2-2.5%              2.5% *         

Unemployment Rate                  4.3-4.5%              4.3%    

PCE Deflator                              2.6-3.1%              2.8%      

Core PCE Deflator                     2.5-2.8%              2.8%

*  H126 average of 1.6% Q126 Real GDP Growth and Atlanta Fed Model Estimate of 3.3% for Q226.

 

 

 

A Supportive Macroeconomic Background Continues

The stock market should continue to be subject to two non-economic factors this week: /1/ a pullback in tech stocks, possibly in anticipation of large IPOs and /2/ developments in the Iran war.  The macroeconomic background remains supportive.  This week's release of the May CPI is expected to show a more subdued Core than in April.  And, the May Employment Report points to moderate economic growth with contained wage inflation.  The latter keeps open the door for Fed policy easing at some point.

Consensus looks for the run-up in oil prices to continue to impact the May CPI.  It expects +0.5% m/m for the Total and 0.3% for Core, which would lift the y/y for both.  The risk is for a higher-than-consensus Total and lower-than-consensus Core.  However, with oil prices having declined in the past week or so, the market will likely dismiss a high Total.  The downside risk to Core comes from /1/ the possibility that Primary and Owners' Equivalent Rent fall back to 0.2% m/m rather than 0.3% after the technical catch-up boosted them to 0.5% in April and /2/ no significant speedup in other components.  The lower print should keep the y/y steady at 2.8%.

The May Employment Report implied no need for the Fed to change monetary policy, but it did not close the door for an easing at some point.  The contained Average Hourly Earnings should encourage Fed officials to expect price inflation to eventually move down toward their 2% target once the oil and tariff shocks dissipate.  And, there may have been less than meets the eye with regard to the jobs growth:    

First, although the Report showed a larger-than-expected +172k m/m increase in Nonfarm Payrolls, the increase was narrowly based.  Only 3 sectors accounted for most of the gain: Leisure and Hospitality (+70k), Health Care and Social Assistance (+47k), and State Non-Education Government (+44k) -- +161k in total.  Most other sectors were little changed.  Second, Private Payrolls slowed for the second month in a row, slowing more between April and May than between March and April (-57k versus -25k).  The large gains in March and April conceivably could be just a post-winter rebound, and the more moderate May increase could be on a path to a trend-like pace.      

                                 Private Payrolls (m/m change, 000s)

                                    Jan     Feb      Mar    Apr    May

                                    180     -148       202     177    120                   

The steady 4.3% Unemployment Rate and trend-like 0.3% m/m Average Hourly Earnings (AHE) support the Fed's view that inflationary pressures are not stemming from the labor market.  The moderate pace of wage gains continued to be fairly widespread.   Eight of thirteen sectors showed AHE up by 0.3% or less, not much different from the nine in April when AHE overall rose 0.2%.  The y/y fell to 3.4% from 3.6%, keeping it line with other measures of labor cost inflation.  

Another Report last week underscored the absence of inflation pressures from the labor market.  Compensation/Hour -- the broadest measure of labor costs -- was revised down sharply for both Q425 and Q126 (see table below).  The downward revisions brought the y/y to 3.3% in Q126.  It was 4.3% in Q425 and 4.9% in Q424.

                 Percent Change

        (q/q, saar) 

Compensation/Hr Unit Labor Costs

Revised  Prelim Revised Prelim

Q126     2.1    3.1     1.8   2.3

Q425    3.7    6.3             2.1   4.6

There was some evidence in the May Employment Report supporting the perception that job search by college graduates is difficult.  Both Labor Force Participation and Employment fell for people with a college degree in May.  The lower Participation could reflect discouragement.   The lower Employment shows weak hiring.  Nevertheless, Participation fell by more than Employment, so the Unemployment Rate for them dipped to 2.7% from 2.8% in April.

 

   

 

   

What Will Be Important In The May Employment Report?

The stock market should continue to be dominated by developments in the Iran war this week.  It should take the May Employment Report in stride, as consensus expects little deviation from recent trends.  The wage component could be important for stocks, particularly if it comes in on the soft side. 

The Unemployment Claims data support the consensus expectation of a slowdown in May Nonfarm Payrolls.  Continuing Claims rose between the April and May Payroll Survey Weeks.  Consensus looks for +96k m/m, versus +115k in April.  Private Payrolls (Total Ex Government) are seen slowing to +85k from +123k.   Continuing Claims correctly predicted speedups/slowdowns in Private Payrolls in 10 of the past 12 months, but it missed in April (see table below).  

The Claims data suggest little change in layoffs and hiring in May.  Initial Claims averaged 209k per week in May, about the same 208k seen in both April and March.  Continuing Claims have moved up slightly since the April Payroll Survey Week.  

An historically weak Payroll gain mostly reflects the slowdown in population growth, tied to the drop-off in immigration.   An increase in the 50-100k range would be consistent with little change in the Unemployment Rate if there is no change in the Labor Force Participation Rate.  Consensus looks for a steady 4.3% Unemployment Rate in May, suggesting near-trend job growth.  A speedup in GDP Growth would depend on a longer workweek, increased labor force participation, or faster productivity growth.  AI would work through the last channel.  Consensus looks for a steady 34.3 Hour Nonfarm Workweek in May.

With the bulk of the May Employment Report expected to be consistent with near-trend growth, the most important component could be Average Hourly Earnings (AHE).  A consensus 0.3% m/m or lower print would suggest that the run-up in oil and other commodity prices have not resulted in a wage-price spiral so far.  It would support the Fed's preference for a wait-and-see policy approach.

                                     Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS    Continuing Claims *        

    April  25             62                          167                            133                               14                            

    May                    37                          140                              69                              -74           

    Jun                    -33                            74                             -27                              -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                               -4                                 2                            

   Sep                    -32                           119                              104                             28 

   Oct                     42                             na                                  1                             -41 

   Nov                   -32                            69                                41                               14

    Dec                   41                            37                                 48                               30     

    Jan 26               22                          172                               146                               94   

   Feb                    63                           -86                              -148                              -14   

   Mar                   62                           186                               190                                 6     

   Apr                  109                          123                                  na                               40    

   May                122                            na                                   na                               -9                                                                              

 * the inverted change in Continuing Claims between Payroll Survey Weeks, 000s  

 

US/Iran Development May Impact Fed Policy Positively For Stocks

The stock market rally should get a boost from the announcement of an apparent movement toward  a 60-day cease fire in the Iran war and opening up of the Strait of Hormuz.  It raises the possibility of an unwinding of the run-up in oil prices, although the extent and speed of a price drop are uncertain.  The announcement comes on top of very strong corporate earnings (with the S&P 500 earnings up 27% y/y in Q126).  And, the macroeconomic background remains positive.  The latter continues to show solid growth, little change in the labor market, and high inflation.  However, much of the high inflation can be attributed to relative price changes resulting from tariffs and higher oil prices -- the latter which now look likely to be temporary.

The effects of a US/Iran agreement could impact Fed monetary policy.  A significant drop in oil and other commodity prices, if they in fact happen, would unwind the run-up in inflation in the past few months from their war-related surge.  As a result, Fed officials may hold back from altering the FOMC Statement to eliminate an easing bias at the next meeting on June 16-17, in contrast to the sentiment expressed at the April 28-29 meeting (see below).  The new Fed Chair Kevin Warsh, who is likely to be more open to easing than Powell, could argue to keep the Statement as is now that oil prices may be moving down (or already have by the time of the Meeting).  Maintaining an easing bias in the Statement would be a positive for the stock market.

The Minutes of the April 28-29 FOMC Meeting did not contain any surprises.  The Fed staff raised its economic forecast a bit, looking for growth to exceed its longer-run 1.8-2.0% potential pace over the next few years.  It cited "favorable financial conditions, continued gains in AI-related capital spending, and a reversal of some of the factors that were expected to weigh on activity this year, including weak foreign growth and uncertainty about the outlook."  The Unemployment Rate was expected to remain close to current levels into 2027 before dipping in 2028.  Inflation was expected to slow in the second half of 2026 as the one-off effects of tariffs and the Iran war wear off.  It is seen slowing to close to 2.0% by the end of the year.  There were downside risks to the real-side forecasts and upside risks to the inflation forecast.  A drop in energy prices should reinforce the thrust of this outlook.  

Most participants' views appear to be similar to the staff's forecast.  Regarding inflation, they noted that measures of longer-term inflation expectations remain stable.  However, "the vast majority of
participants noted an increased risk that inflation would take longer to return to the Committee’s
2 percent objective than they had previously expected."  In contrast, while "participants generally expected labor market conditions to remain stable in the near term ... most judged the risks to the employment side of the Committee's dual mandate were tilted to the downside."  

The combination of contained longer-term inflation expectations and balanced risks calls for steady monetary policy, which the Committee members agreed is the case.  However, there was concern that higher rates in the future might be necessary.  "A majority of participants highlighted, that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 percent. To address this possibility, many participants indicated that they would have preferred removing the language from the post-meeting statement that suggested an easing bias regarding the likely direction of the Committee’s future interest rate decisions."  

The latest update of the University of Michigan Consumer Sentiment Survey's measure of longer-run inflation expectations was likely a concern to these Fed officials.  The 5-Year Inflation Expectations jumped to 3.9% in May, well above the 3.2-3.4% recent range.  However, the May level is still within the 3.2-4.4% range seen since March 2025 and now, with a potential US/Iran agreement in sight, could be discounted as temporary.

 

 

 

 

A Hawkish Fed?

The stock market should continue to be impacted by the Iran war and corporate earnings this week.  It also will likely focus on the release of the April 28-29 FOMC Minutes on Wednesday for signs of a more hawkish Fed.  While the Minutes should show some movement in sentiment away from policy easing prospects, they will affirm that steady policy is currently the appropriate stance.  Although a steady policy should be neutral for stocks, the shift in sentiment could exacerbate the market consolidation that began on Friday.  (This exacerbation could be short-lived since Nvidia reports earnings after the close on Wednesday.)  Rate hikes at future FOMC meetings could be the factor that eventually derails the stock market rally.  The latest inflation-related data don't call for one as yet -- steady Fed policy is appropriate.

Fed Chair Powell gave insights into the policy debate at the April FOMC Meeting during his post-meeting news conference.  He made four points about monetary policy:  /1/ The current steady policy is in a good place -- able to move in either direction if needed, /2/ The Fed funds rate is now at the high side of neutral or slightly restrictive, /3/ There is too much uncertainty to say what the next policy move will be, and /4/ While there was a shift among FOMC members to move toward a more neutral stance in the FOMC Statement, they decided it was not appropriate to do so at this meeting.  

The Minutes may not be much different from those of the prior meeting (March 17-18 FOMC Meeting). The latter showed concern about high inflation, but more in terms of a potential future threat.   At this earlier meeting, officials said that a long Iran war could result in "more persistent increases in energy prices and these higher input costs would be more likely to pass through to core inflation."  Officials concluded that "progress toward the Committee's 2 percent objective could be slower than previously expected and judged that the risk of inflation running persistently above the Committee's objective has increased."  Many officials said this situation "could call for rate increases to help bring inflation down to the Committee's 2 percent objective and keep longer-term inflation expectations firmly anchored."  However, most participants held to the position that they should wait and monitor developments before deciding on the "appropriate stance of monetary policy."  The important word to looks for in the April Minutes is whether "Many" becomes "Most" in a sentence calling for rate increases at some point.

Regarding inflation, last week's data gave a somewhat distorted picture, but underscored that the pass-through of higher oil and other commodity prices will likely lift prices of other goods and services.  The distortion was in the April CPI, while the pass-through effect was pronounced in the April PPI.

The high prints for the April CPI (+0.6% m/m Total and +0.4% Core) reflected a technical adjustment to Primary and Owners' Equivalent.  Their calculation involves comparing the sample's rents with what they were six months earlier.  In April 2026, the 6-month comparison was with October 2025.  The latter, however, was not measured because of the government shutdown.  BLS had plugged in the level of April 2025 for October 2025.  This substitution was lower than it would have been had it been measured, so the 6-month change in April 2026 was lifted as a result.   It is a one-off adjustment, so Primary Rent and OER should revert to the 0.2-0.3% m/m trend in May.  If this trend had been used in April 2026, Total would have been 0.5-0.6% and Core would have been 0.2-0.3% (2.4-3.7% annualized).  So, the high prints overstated inflation, and a more accurate measure shows core inflation only somewhat above the Fed's 2% target.

There are still risks that inflation will pick up as higher energy and commodity prices are passed through and other special factors spark price hikes.  The April PPI shows these channels.  The April PPI prints were high (Total +1.4% m/m Total and +0.6% Core Less Trade Services).  However, there were only a few Core components with large increases.   Some clearly resulted from a pass-through of higher oil prices.  Freight transportation -- rail, air and truck -- surged.  Other special factors may have been responsible for large increases in other areas --Electronic Components, Household Furniture, and Internal Combustion Engines.  All these price increases presumably will show up in consumer prices in coming months.

The prospect for higher prices ahead should keep the Fed on hold.  However, in principle the Fed should not react by tightening policy if oil or other special factors are responsible.  The higher prices are better viewed as relative price changes than a ratcheting up of inflation.  At some point these prices and their pass-through will stop.  The Fed should be more concerned if the higher prices spur a speedup in wage increases.  This could result in a wage-price spiral -- true inflation.  So far, wages remain in check.  So, prospects for a wage-price spiral are not an actionable risk at this point and the Fed can afford to wait.

 

 

 

Not-So-Bad CPI?

The stock market should continue to be dominated by developments in the Iran war and corporate earnings this week.  It also will likely focus on inflation data -- April CPI and PPI.  They are expected to be lifted by higher energy prices and tariffs.  However, there is a risk that consensus estimates are too high.  Even if they're not, the market will probably discount high prints as temporary.  A below-consensus print should be viewed positively as keeping the door open for a Fed easing at some point.

Consensus looks for a high April CPI, with Total up 0.6% m/m and Core up 0.4%.  Airfares are likely a major catalyst behind these estimates, reflecting higher fuel costs.  However, there are reasons to think there could be some offsets.  Seasonal factors hold down Airfares substantially this month.  Also, there could be offsets in other CPI components.  Owners' Equivalent Rent could revert to the smaller increases seen in Primary Rent seen since January.  Also, Lodging Away From Home (hotels) could remain modest for a second month in a row, helped by seasonal factors.  And, the impact of tariffs on items like Apparel could ease. 

A lower-than-consensus CPI print would suggest that a moderation in inflation will accompany moderate economic growth ahead.  Friday's April Employment Report supported this outlook.  Although job growth exceeded consensus, the growth was not widespread.  Almost all of the gain was accounted for by only three sectors -- Health Care, Transportation and Warehousing, and Retail.  There also was a sizable increase in part-time jobs for economic reason, according to the Household Survey.  Nevertheless, the Nonfarm Workweek rebounded, helping to lift Total Hours Worked 0.8%(annualized) above the Q126 average.  This q/q increase is in line with the 1.0% (q/q, saar) increase in Q126, when Real GDP Growth was 2.0%.  The steady 4.3% Unemployment Rate also suggests near-trend GDP Growth.  Regarding inflation, the Employment Report shows that wage inflation remains in check.  Average Hourly Earnings rose only 0.2% m/m for the second month in a row.  

This week's releases of real-side US economic data are expected to support the idea of decent growth in Q226.  Both April Retail Sales and Industrial Production are expected to climb.   Although the data appear to be lining up to reflect near-trend growth, the Atlanta Fed model's early estimate of Q226 Real GDP Growth is a strong 3.7% (q/q, saar).  This would require a jump in productivity, given the moderate increase in Total Hours Worked, perhaps AI-related at least to some extent.  Of course, the model's estimate is subject to change as more data come in.  At this point, the risk would seem to be that the estimate will come down.

 

 

Strong April Employment Report?

The stock market should continue to be dominated by developments in the Iran war and corporate earnings this week.  The latter have been beating expectations.  The April Employment Report also will be a focus, particularly since there is disagreement among Fed officials whether the FOMC Statement should be biased toward an easing.

Economic growth is back to looking on the speedier side going into the Spring.  Besides a spate of solid data last week, some evidence points to a strong April Employment Report this week.  If the latter is the case, the market will likely agree with the three dissenters at last week's FOMC Meeting who wanted to eliminate the easing bias in the FOMC Statement.  Looking ahead, a slowdown in inflation in coming months, as the effects of tariffs and oil prices end, may be what triggers a Fed rate cut -- rather than a weakening economy.

Consensus expects a moderate Employment Report.  Nonfarm Payrolls are seen slowing to +73k m/m from +178k in March.  Strike adjusted, the comparison would be +74k versus +146k.  A steady 4.3% Unemployment Rate also is expected, as is a return to a trend 0.3% m/m increase in Average Hourly Earnings after +0.2% in March.  

Some evidence argues for stronger prints.  The Unemployment Claims data suggest a speedup in Payrolls from the March pace, as Continuing Claims fell by more between Survey Weeks in April than in March (see table below).  This relationship has remained a more accurate predictor of speedups/slowdowns in Private Payrolls than has the ADP Estimate.  The April Conference Board Consumer Confidence Survey was more upbeat about the labor market, as well.  The spread between Jobs Plentiful and Jobs Hard to Get increased m/m.  Rounding analysis shows that a 4.2% print for the Unemployment Rate can't be ruled out.  The Rate was 4.26% in March, not far off a rounded 4.2%. 

Last week's US economic data surprised on the strong side.  In particular, Durable Goods Orders Excluding Transportation posted large increases of 0.9-1.2% m/m in March and February, well above the 0.6-0.7% pace in H225.  In particular, Nondefense Capital Goods Orders Excluding Civilian Aircraft surged 3.3% m/m after +1.6% in February and 0.8% on average in H225.  High Tech orders were a major contributor to the February-March increases.  They point to further strength in business equipment investment ahead.

Most of the inflation-related data released last week were higher than desired by the Fed.  The Core PCE Deflator rose 0.3% m/m, which pushed up the y/y to 3.2% from 3.0%.  And, the Q126 Employment Cost Index sped back up to the prevalent 0.9% q/q pace of the previous year and a half, following a 0.7% increase in Q425.  At best, it points to steady underlying inflation.  However, Kevin Warsh, the nominee for Fed Chair, should be happy that the Dallas Fed Trimmed PCE Deflator rose only 0.2% m/m in March.  Its y/y edged up to 2.4% from 2.3%, staying closer to the Fed's 2% target than the official Core PCE Deflator.   

                                     Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS    Continuing Claims *        

    March  25          155                          209                            120

    April                   62                          167                            133                               14                            

    May                    37                          140                              69                              -74           

    Jun                    -33                            74                             -27                              -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                               -4                                 2                            

   Sep                    -32                           119                              104                             28 

   Oct                     42                             na                                  1                             -41 

   Nov                   -32                            69                                41                               14

    Dec                   41                            37                                 48                               30     

    Jan 26               22                          172                               146                               94   

   Feb                    63                           -86                              -129                              -14   

   Mar                   62                           186                                  na                                 6     

   Apr                  109                           na                                   na                               40                                                                                

 * the inverted change in Continuing Claims between Payroll Survey Weeks, 000s