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.