This Week's US Economic Data Likely To Suggest Modest US Econonomic Outlook

This week's key US economic data are likely to argue for only a modest pickup in GDP growth ahead.  Most of the data are likely to soften or print weaker than consensus.   But, Average Hourly Earnings risk speeding up.  The data should keep the Fed on a gradual tightening path, and the Treasury yield curve risks flattening further.   Nevertheless, stocks are likely to remain in an uptrend in May, particularly as strong earnings reports will probably continue.  The risk, however, is that the stock market rally will pause in early summer, unless progress is made on a Trump tax cut. 

       US Economic Data         Consensus           Prior           Q117 Average          Risk   
       April Mfg  ISM                56.4                      57.2              57.0                 Near Consensus

      ADP Estimate                   175k                     263k            269k                 Below Consensus

      Non-Mfg ISM                   55.8                      55.2             54.1                  Below Consensus

      Nonfarm Payrolls             185k                      98k              178k                 Below Consensus

      Unemployment Rate         4.6%                     4.5%            4.7%                Near Consensus

      Average Hourly Earnings  0.3%                    0.2%            0.2%                 Near Consensus

Real GDP Growth should speed up in Q217 from the weak 0.7% Q117 pace.  Monday's release of March Personal Income/Consumption/PCE Deflator should indicate a good-sized take-off point in Real Consumption, particularly since the nominal increase in March Consumption should be boosted in real terms by a decline in the PCE Deflator (Total and Core).  But, it is much too soon to have a good handle on the extent of a Q217 Real GDP speedup.   Real GDP Growth may speed up to only 1.5-2.0% in Q217, particularly since there are reasons why inventory investment may not bounce back -- retail store closings could reduce inventories further;  and, an inventory correction in the motor vehicle sector may very well continue.

Modest US economic growth could continue in H217, particularly if the Fed hikes again at the June FOMC Meeting or further talks up selling off its balance sheet.  The ECRI Leading Index already looks like it has peaked (see below). 


     ECRI Leading Index (level)
 
               7/15                   2/16                           11/16                 4/17                              







                    

Weak Q117 Real GDP, the Fed and a Trump Tax Cut

The weak Q117 Real GDP Growth is not likely to deter the Fed from pursuing 2-3 rate hikes in the remainder of the year.  The low print reflected a couple of temporary factors, as discussed below.  However, while Real GDP Growth should speed up in Q217, Nonfarm Payroll growth is likely to come in around or below the +178k Q117 average m/m pace.  For next week's April Employment Report, consensus expects +180k m/m Payrolls.  My expectation is around 150k.

The 0.7% (q/q, saar) increase in Q117 Real GDP Growth came in between the 0.5% Atlanta Fed model's estimate and the 1.1% consensus -- in line with my expectations (see prior blog).  The weakness can be attributed primarily to a sharp slowdown in inventory investment after it popped in Q416 (subtracting 1.0% pt from Q117 Real GDP growth) and a temporary drop in consumer spending on heating utilities as a result of the warmer-than-normal winter.  Without these two drags, Q117 GDP Growth would have been about 2.0%.

Real GDP Growth should speed up in Q217.  Consumer spending on utilities will rebound in Q217 as the weather returns to normal.  And inventory investment is not likely to slow as much as in Q117.  However, the pace of inventory investment could remain subdued.  Retail store closings could reduce inventories further.  And, an inventory correction in the motor vehicle sector may very well continue.  The latter appears to be part of the weakness in inventory investment in Q117, as motor vehicle output fell sharply then.

Inflation was high in Q117, but it could just reflect volatility.  The Core PCE Deflator rose 2.0% (q/q, saar) in Q117, but this followed a low 1.3% in Q416.   The y/y was 1.7% -- still below the Fed's 2.0% target.  Note that the March Total and Core PCE Deflator, due Monday, risk falling m/m.  In another report today, the Q117 Employment Cost Index jumped 0.8% q/q.  But, this could be a one-off start-of-year pop.  The y/y moved up for the second quarter in a row.  But, at 2.4%, the y/y is in line with those of other labor cost measures.

The low Q117 Real GDP Growth will probably prompt anti-Trump analysts to blame him and pro-Trump analysts to say it argues for a tax cut.   Neither is correct.  Without the two drags mentioned above Real GDP Growth was slightly above trend.  My view of a tax cut is that it makes sense in the current situation of near full employment if it works to boost trend or potential GDP Growth.  There are two ways this could happen -- /1/ it leads to higher productivity growth  or /2/ it leads to faster labor force growth.  Tax supporters would say that lower corporate tax rates would spur investment spending, which leads to higher productivity growth.  The problem is that the US capital stock is so large that a reasonable pickup in investment spending would not boost the capital stock by much.   Tax supporters also would say that cutting individual tax rates would bring people back into the labor force.  The problem here is that demographics may work against this effect -- which may be measurably small to begin with.

Market Focus to Return to US Economy and Fed

The wall of worry that was building over the past two weeks appears to be crumbling quickly.  The French presidential election was benign, and the final outcome is a couple of weeks away.   Republican efforts to reform ObamaCare and the tax code are moving ahead, according to news reports.  Although it is not yet clear whether they will succeed, positive expectations have been lifted.  And, the North Korean crisis looks to have faded into the background.  A potential federal government shutdown remains a risk, but may have only a small market impact since it shouldn't last long.

Markets will likely return to focus on the US economy and Fed policy.  The economic outlook is for modest/moderate growth continuing in Q217 with little change in inflation.  There should be reversals in some key data, with the strong data of Q117 -- job growth -- slowing while the weak data of Q117 -- GDP -- speeding up.  Gradual monetary policy tightening should remain on track in this outlook.  

In the coming week, the unwinding of the wall of worry will likely hurt Treasuries and help stocks through Wednesday, when Trump is scheduled to present his tax reform ideas.  Then, the US economic data are likely to turn softer and work to reverse these market moves somewhat into the following week.  Stocks, however, still should be helped by mostly strong Q117 earnings reports and a decent macroeconomic background.  So far, earnings are said to be running over 10% y/y, north of expectations.  And, the upcoming data, while softer, should still be strong enough to sustain the outlook for good economic growth.  The combination of strong profits and decent growth may very well create a window for an upside break in the S&P 500 above its recent range.

The most important US economic data next week should be the advance report on Q117 Real GDP Growth.  Most estimates are for a weak print, below the 1.5% Fed estimate of the longer-term trend in GDP.   Consensus is 1.1% (q/q, saar),  while the Atlanta Fed model projects 0.5%.  I would not be surprised to see Real GDP come in somewhere between these two estimates, as the monthly data on three key components -- consumption, inventory investment and exports -- are weak.  In contrast, the NY Fed model projects 2.5%, but this model seems to rely mostly on survey data, such as the Mfg ISM, which were stronger than real-side data in Q117.

Some analysts are likely to dismiss a weak GDP print as resulting from a downward bias from seasonal factors in Q1.   But, this idea is questionable, inasmuch as there should be enough data from the past few years to eliminate such a bias in the seasonal adjustment estimation.  I think it more likely that weakness in Q117 GDP may have been carryover from the business/consumer caution following the presidential election.  This caution ended in the labor market, as Payroll Growth sped up in Q117.  Similarly, there should be a lagged speedup in GDP Growth in Q217.   How much of a speedup is not clear at this point, however.  

The following week will likely see a moderation in the US economic data that were strong in Q117 -- Nonfarm Payrolls and Mfg ISM.  While Payrolls should speed up from the +98k m/m March print, they should climb by less than the +218k January-February average.  My guess is around 150k -- which is still above the 75-125k pace the Fed considers consistent with a steady Unemployment Rate.  The Mfg ISM could come off a bit, as have a number of regional surveys.  I would pay attention to the Richmond Fed Mfg Index, due April 25, for the most reliable clue, as it has moved in the same direction as Mfg ISM each month since June 2016.

Upcoming inflation data should be mixed.  The March PCE Deflator, due May 1, could fall even more than did the March CPI (-0.3% m/m Total, -0.1% Core).   But, one-off factors would be behind a decline, as they were in the CPI.  Labor Costs should keep the inflation story alive.  Consensus looks for the Q1 Employment Cost Index, due April 28,  to speed up to 0.6% q/q  in Q117 from 0.5% in Q416.  April Average Hourly Earnings, due May 5, risk printing a high 0.3% m/m (3.0% y/y), as a result of calendar considerations that had helped hold down AHE in February and March.

A Wall of Worry

A wall of worry is building in the markets -- helping Treasuries and hurting stocks.  Although last week's military scares proved benign (and possibly have positive effects), they may have left concern that other seemingly random actions or threats from the Trump Administration will precipitate worse outcomes.  Meanwhile, some political analysts are not dismissing a Le Pen victory in the upcoming French presidential election, having learned their mistake last November.  And, expectations of tax reform in the US appear to need proof that Trump is able to propose and get passed a reasonable piece of legislation.  Nevertheless, these fears could fade over the next couple of months.

The macroeconomic background looks to be marked by moderate US economic growth and contained inflation.  Some of last week's data looked soft on the surface, but showed decent underlying components (see below).  Some analysts have been highlighting the very weak 0.5% (q/q, saar) Atlanta Fed model's projection for Q17 Real GDP.   Indeed, Fed staff in Washington said in the March FOMC Minutes that it looked for GDP Growth to be slower than the 2.1% Q416 pace.  In contrast, the NY Fed's model projects 2.6% for Q117 Real GDP Growth.  It was closer to the mark than the Atlanta Fed's model in the prior two quarters.  The NY model now forecasts 2.1% for Q217 Real GDP growth.

The Fed is likely to view any GDP growth above 2.0% as justification to tighten further, since officials view trend to be around 1.5%.  A sharp correction in stocks or surge in the dollar (on a Le Pen victory) could stop the Fed in June, however, taking account NY Fed President Dudley's speech on the importance of financial market conditions in policy deliberations.  Arguably, the Fed already tightened another 25 BPs through forward guidance when in the March Minutes officials emphasized the possibility of beginning to run off longer-term securities from the Fed's balance sheet late this year. 

Last Week's US Economic Data
Both March Retail Sales and the CPI came in on the soft side on Friday.  But some of the Retail Sales weakness masked underlying strength.  And, some of the CPI weakness was likely a result of one-off price declines.

The -0.2% m/m Total and 0.0% Ex Auto Retail Sales were held down by a weather-related drop in building materials sales.  This component is not used in the construction of Consumer Spending in GDP.  The underlying Retail Sales Control measure -- Sales Excluding Auto/Gasoline/Building Materials -- rose a decent 0.3%.  While this followed a downward-revised -0.2% in February, the March level is 0.5% (annualized) above the Q117 average -- making it a decent take-off point for Q217 sales.  Moreover, the decline in the March CPI points to an even larger gain in Real Retail Sales Control.  The Q117 sluggishness in Real Consumption may have been a lagged response to the jobs slowdown in Q416, as well as a temporary drop in spending on utilities thanks to the warm weather.  The speedup in job growth in Q117, as well as a return to normal weather, could spur an improvement in the Consumer Spending growth in Q217.

The fact that Initial Unemployment Claims surprised to the downside in the latest week, falling 1k to a still-low 234k, says that economic growth remains good.

                                    Initial Claims (level, 000s)
       Apr 8 Wk                             234
       Apr 1 Wk                             235
      
       Mar Avg                               252
       Feb Avg                                234    
       Jan  Avg                                243

       Q416 Avg                             256

But, economic growth so far this year has not led to a pickup in inflation.  The January-February average core inflation rate is the same this year as last (see table below).  After the decline in March, the 0.13% 3-month average is now below last year's.  To be sure, the March decline in core inflation is not likely to repeat itself in April, as some large declines were likely one-off -- such as a 5.0% plunge in the price of telephone services, resulting presumably from the shift to unlimited data plans by the major providers, which subtracted 0.15% pt from the m/m change in the Core CPI.  And, some other prices, like apparel and new vehicle prices look to be offsets to earlier jumps.  But, other components maintained their subdued trend, as well.  On balance, core inflation should be predominantly in the 0.1-0.2% m/m range the rest of the year.  This should keep the y/y fairly steady.  The Core CPI has to average below 0.19% m/m in April-May to stay under last year's pace for those months.  It has to average below 0.13% m/m from April through December to stay under the 2016 pace for the remainder of the year. 

                                                              Core CPI (m/m percent change)
                                                                     2017               2016
                                January                        0.31                  0.27
                                February                      0.21                  0.25
                                March                         -0.12                  0.09

                                3-month avg                 0.13                 0.20                        

March Employment Report Should Not Stop the Fed From Hiking

The March Employment Report is not likely to derail the Fed's intention to tighten 2-3 times more this year,  although it brings the labor market data more in line with the Atlanta Fed model's projection of sluggish 1.2% Q117 Real GDP.  The weakness in Payrolls is probably temporary, and calendar considerations argue for a speedup in Average Hourly Earnings in April.   The risk is for Fed officials to emphasize the temporary nature of the March weakness, particularly since financial market conditions remain strong. 

To a large extent, the weakness in March Nonfarm Payrolls was a one-off payback for the warm-winter boost in January-February.  Also, some of the weakness resulted from a drop in Department Store jobs, which could have stemmed from the widely-reported store closings.  The firings could have been a factor behind the run-up in Initial Claims in March, as well.  But, the drop in Initial Claims in yesterday's release suggests that the job losses in this area may be ending.  Initial Claims remain an important piece of data to watch in coming weeks.  I would not be surprised to see Payrolls move back up to the 150-175k range in Q217.  

The Payroll data, however, support the possibility of a slowdown in Q117 Real GDP Growth.  Nonfarm Payrolls averaged +178k m/m in Q117, after the +98k m/m increase in March Payrolls and 38k downward revisions to January-February.  The Q117 average is above the +148k Q416 average but below the +193k H216 average.  Although job growth sped up relative to the Q416 pace, there was an offset from a lower Average Workweek in February and March.  As a result, Total Hours Worked slowed a bit to 1.5% (q/q, saar) from 1.7% in Q416.   This slowdown in THW is no guarantee that GDP Growth slowed in Q117 from the 2.1% Q416 pace, but is supportive of this possibility.  Note that Fed Board staff looked for a slowdown in Q117 Real GDP Growth in its briefing for the March FOMC Meeting, but blamed temporary factors that should reverse in Q217.

The Unemployment Rate also does not rule out a slowdown in Q117 Real GDP Growth.  The drop in the Unemployment Rate to 4.5% from 4.7% in February can be viewed as bringing the Rate more in line with the stronger job growth in the prior two months.  The Rate averaged 4.7% in Q117, essentially unchanged from the Q416 average and consistent with GDP Growth near the 1.5% estimated trend.

Wage inflation remains contained according to the March Employment Report.  The 0.2% m/m increase in Average Hourly Earnings lowered the y/y to 2.7% from 2.8% in March -- keeping it within its recent range.  But, the risk is for AHE to speed up in April, based on calendar considerations, which would lift the y/y to 3.0%.  These calendar considerations worked to hold down AHE in February and March.