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