Here are two reasons the stock market should continue to rally after the Fed hikes the funds rate by 25 BPs at the June 13-14 FOMC Meeting. First, stocks should view it as indicative of Fed confidence that the rate hike will not deter moderate economic growth ahead. Second, stocks, as well as other markets, should move in directions that work to achieve the Fed's goal of sustained moderate growth -- an "optimal control" approach to understanding markets.
The May FOMC Minutes show Fed staff more confident of
above-trend economic growth over the next few years -- even with
additional monetary policy tightening. The Minutes said "Beyond the
near term, the forecast for real GDP growth was a little stronger, on
net, than in the previous projection, mostly due to the effect of a
somewhat lower assumed path for the exchange value of the dollar. The
staff continued to project that real GDP would expand at a modestly
faster pace than potential output in 2017 through 2019, supported
in part by the staff’s maintained assumption that fiscal policy
would become more expansionary in the coming years." This improved outlook possibly could show up in the updated Central Tendencies released at the June meeting, although the Central Tendencies reflect a composite of the District Fed forecasts and not the Board staff's forecast.
The "optimal control" approach to understanding markets is based on the idea that the major markets -- stocks, bonds and foreign exchange -- move in directions that work to achieve the Fed's goals. With the Fed wanting to raise the level of the Fed funds rate to its longer-term equilibrium level, the tighter short-end of the Treasury yield curve works against its other goals of sustaining moderate economic growth and lifting inflation. So, the long-end of the Treasury curve, stocks and dollar will work to offset this tightening -- stocks should climb, while long-term yields and the dollar should fall. To be sure, since there are more "controllers" than targets, not all the markets will necessarily move in the right direction. But, if one market moves in the wrong direction, the other markets would have to work harder to achieve the Fed's targets. At the moment, the three major markets are moving consistently with the growth/inflation targets -- stocks are up, while longer-term yields and dollar are down. (This combination has perplexed many market commentators, who, based on conventional theory, expect these markets to move the opposite way in the face of a Fed tightening.) With the Fed likely to hike 2-3 times more this year (in June, September and December), these markets have room to move further in the "right" directions, according to an optimal control approach.
The Fed is likely to lift the funds rate by 25 BPs in June, even though forecasts of Q217 Real GDP Growth have come down after the latest batch of data. The Atlanta Fed and NY Fed models now project 3.6% and 2.1%, respectively (was 4.1% and 2.2%), after April data showed a widening in the trade deficit and soft inventory investment, while Q117 Real GDP was revised up to 1.2% from 0.7% (the latter in part a result of a smaller drag from one-off consumption weakness that implies a smaller rebound in Q217). The lower forecasts, however, still are above the 1.5% long-term trend.
The latest Unemployment Claims fell further in May, providing evidence that above-trend economic growth and the tightening trend in the labor market are being sustained into the Spring.
Initial Claims (level, 000s)
May Avg to Date 234
Apr Avg 241
Q117 Avg 243
Q416 Avg 256
This week's key data should not deter a June Fed rate hike, despite soft inflation prints. Although April Total and Core PCE Deflator are expected to show a slowdown on a y/y basis, Fed officials could dismiss it -- based on the May FOMC Minutes. The Minutes said, "Core PCE price inflation, which historically has been a good predictor of future headline inflation, moved down to 1.6 percent over the 12 months ending in March. However, it was noted that some of this slowing reflected idiosyncratic factors such as a large drop in the measure of quality-adjusted prices for wireless telephone services." Downplaying the drop in wireless telephone services is debatable, since the introduction of unlimited phone plans suggests excess capacity that may persist. But, its downplaying shows Fed officials are not yet willing to trend out the idea of slower inflation ahead. Note that the dovish Fed Governor Brainard speaks again on Tuesday, so she'll have a chance to weigh in on low inflation if she wants.
This week's real-side data should argue for a rate hike. Evidence on the May Mfg ISM is mixed, with Phil Fed Index up but Richmond Fed Index down. Whatever prints, the level of the Mfg ISM should be decent. The May Employment Report should show a decent gain in Payrolls, but perhaps not as strong as the +179k consensus, and a steady to lower Unemployment Rate. But, Average Hourly Earnings should be soft and weaker than the 0.2% m/m consensus. Calendar considerations suggest 0.1% m/m (2.4% y/y versus 2.5% in April).
Monday, May 29, 2017
Sunday, May 21, 2017
Stock Market Should Retain a Positive Tone, But...
The stock market is likely to retain its positive tone this week, thanks to strong US and global economic growth. But, any rally may be limited for now, as potential negative-Trump news out of Washington, raising doubts about the likelihood of tax reform, hangs over the market. And, the risk of a rate hike at the June 13-14 FOMC Meeting could engender caution, with the caveat that the dovish Fed Governor Brainard speaks late Monday.
The expected rebound in Q217 Real GDP growth and growth-supportive financial markets are positive for stocks but also argue for a June Fed rate hike. Last week, the Atlanta and NY Fed models lifted their forecasts of Q217 Real GDP Growth -- Atlanta to 4.1% from 3.6%, NY to 2.3% from 1.9%. Both forecasts are above the economy's trend pace.
The economy may extend an above-trend pace into Q317, as the financial markets are generating pro-growth forces -- mentioned by NY Fed President Dudley in late March as an important consideration in monetary policy deliberations. While the stock market fell sharply last Wednesday, the rebounds on Thursday and Friday offset much of the drop. Meanwhile, Treasury yields and the dollar fell, keeping measures of financial market conditions in an uptrend. The weaker dollar also is a positive for Q217 corporate profits.
This week's US economic data are minor and should do little to influence Q217 GDP forecasts. Consensus looks for dips in New and Existing Home Sales, but the levels should remain high. On Friday, Q117 Real GDP Growth is seen being revised up to 0.9% from 0.7%. The latter should be a modest positive for stocks, even though the pace is still low.
More important data are due in the following week. They are likely to underscore the economy's strength. May Mfg ISM risks rebounding, as did the Phil Fed Mfg Index (which correctly predicted direction of Mfg ISM in each of the past 5 months). The May Employment Report should preserve the theme of a strong labor market with low wage inflation. A decent gain in Payrolls and decline in the Unemployment Rate are the risk, based on the further improvement in the Claims data. But, Average Hourly Earnings should be low, about +0.1% m/m, based on calendar considerations, lowering the y/y to 2.4% from 2.5%.
The May 2-3 FOMC Meeting Minutes, due this coming Wednesday, might not reflect the more recent signs of economic strength, since the Statement focused on Q117 GDP weakness -- "the labor market has continued to strengthen even as growth in economic activity slowed." But, the Minutes should indicate an expected speedup in Real GDP Growth in Q217, keeping alive the possibility of a June rate hike.
The dovish Fed Governor Brainard is scheduled to make a speech late Monday, which would be an important positive for the stock market if she argues against a June rate hike on the basis of low inflation. Her speeches have accurately signaled the outcome of an FOMC meeting. However, the June FOMC Meeting would seem to be too far away for her to make decisive statements.
The next significant development in the Trump-Russian controversy is likely to be former FBI Director Comey's testimony to the Senate Intelligence Committee. Although this will occur after Memorial Day, reporters are on the hunt for any leaks or evidence regarding the controversy (and some Administration staff have been happy to accommodate them) -- so headline risk remains this week.
The Congressional Budget Office's costing of the House health insurance bill, due this week, risks setting back the legislative path toward tax reform. But, several House committee meetings also are scheduled this week to work on tax reform. The hope should remain.
The expected rebound in Q217 Real GDP growth and growth-supportive financial markets are positive for stocks but also argue for a June Fed rate hike. Last week, the Atlanta and NY Fed models lifted their forecasts of Q217 Real GDP Growth -- Atlanta to 4.1% from 3.6%, NY to 2.3% from 1.9%. Both forecasts are above the economy's trend pace.
The economy may extend an above-trend pace into Q317, as the financial markets are generating pro-growth forces -- mentioned by NY Fed President Dudley in late March as an important consideration in monetary policy deliberations. While the stock market fell sharply last Wednesday, the rebounds on Thursday and Friday offset much of the drop. Meanwhile, Treasury yields and the dollar fell, keeping measures of financial market conditions in an uptrend. The weaker dollar also is a positive for Q217 corporate profits.
This week's US economic data are minor and should do little to influence Q217 GDP forecasts. Consensus looks for dips in New and Existing Home Sales, but the levels should remain high. On Friday, Q117 Real GDP Growth is seen being revised up to 0.9% from 0.7%. The latter should be a modest positive for stocks, even though the pace is still low.
More important data are due in the following week. They are likely to underscore the economy's strength. May Mfg ISM risks rebounding, as did the Phil Fed Mfg Index (which correctly predicted direction of Mfg ISM in each of the past 5 months). The May Employment Report should preserve the theme of a strong labor market with low wage inflation. A decent gain in Payrolls and decline in the Unemployment Rate are the risk, based on the further improvement in the Claims data. But, Average Hourly Earnings should be low, about +0.1% m/m, based on calendar considerations, lowering the y/y to 2.4% from 2.5%.
The May 2-3 FOMC Meeting Minutes, due this coming Wednesday, might not reflect the more recent signs of economic strength, since the Statement focused on Q117 GDP weakness -- "the labor market has continued to strengthen even as growth in economic activity slowed." But, the Minutes should indicate an expected speedup in Real GDP Growth in Q217, keeping alive the possibility of a June rate hike.
The dovish Fed Governor Brainard is scheduled to make a speech late Monday, which would be an important positive for the stock market if she argues against a June rate hike on the basis of low inflation. Her speeches have accurately signaled the outcome of an FOMC meeting. However, the June FOMC Meeting would seem to be too far away for her to make decisive statements.
The next significant development in the Trump-Russian controversy is likely to be former FBI Director Comey's testimony to the Senate Intelligence Committee. Although this will occur after Memorial Day, reporters are on the hunt for any leaks or evidence regarding the controversy (and some Administration staff have been happy to accommodate them) -- so headline risk remains this week.
The Congressional Budget Office's costing of the House health insurance bill, due this week, risks setting back the legislative path toward tax reform. But, several House committee meetings also are scheduled this week to work on tax reform. The hope should remain.
Sunday, May 14, 2017
Sell in May?
May is the time of year when history suggests moving out of stocks is a good idea, as the market has tended to flatten out between May and October. This year, the best of the stock market rally indeed may be behind us -- but not necessarily if tax reform legislation looks like it will happen. And, consolidation into the June 13-14 FOMC Meeting is a good possibility. But, there is reason to think that the overall market will retain its positive tone into the summer.
Market Complacency
The apparent complacency in the stock market has masked large and offsetting gains and losses among specific companies and industries. There has been significant adjustments in stock prices to fundamental changes at the industry level. So, stock picking has become important. Nevertheless, the complacency -- as seen in the absence of significant volatility in overall measures -- has added to nervousness that the stock market will not be able to maintain its recent rally, particularly with the backdrop of questionable actions by Trump, the slow pace of legislation in Congress, and international hot spots such as North Korea. From a contrarian's perspective, this background is best for a continuation of the rally. A contrarian would worry if most observers don't see any problems.
Washington
Trump's contradictory comments and actions so far have been background noise from a market perspective. While there is a sense among some commentators that Trump's actions and words will undermine US political institutions, this potential result is not close enough to happening to have a noticeable impact on the stock market now. Moreover, although Trump is criticized for switching positions, in some cases, his switch had better implications for the economy than did his original position. This was also the case with the courts' blocking of his anti-immigration order.
The House passage of an ObamaCare repeal has prompted much rancor on the part of Democrats and some support from Republicans. In a sense, both sides won -- Democrats kept a new entitlement program while Republicans succeeded in paring it -- the latter unusual for an entitlement. The legislation has little implication for the overall stock market, except to the extent that its continuing "life" in the Senate will hold back tax reform legislation. Expectations of tax reform, though, remain a positive for stocks -- and the possibility of tax reform argues against any large-scale selling of securities.
The issue of Russian involvement in the election process or the Trump campaign is background noise, as well, unless it leads to impeachment. Ironically, the Russian actions have backfired, inasmuch as no US official will now push for any relaxation of the sanctions without significant concessions by Russia.
One accomplishment by the Trump administration that could have positive benefits for the economy and stock market is the trade agreement with China. This agreement may not have received enough good press. In addition, the pro-business bent of the administration leaves open the possibility of more M&A activity popping up.
Fed Rate Hike
Labor market data have been strong enough to justify a Fed rate hike in June. This has not been the case with inflation data, since the Core CPI and Average Hourly Earnings have slowed on a y/y basis. Fed officials, however, could maintain their view that inflation will speed up ahead as the labor market tightens. So, at this point, the market pricing of an 80% chance of a June Fed rate hike seems reasonable.
If the Fed hikes in June, the stock market could take it in stride if it is viewed as confirmation that the economy is doing well. Moreover, a June hike could ease some concern about future Fed tightening. With some Fed officials comfortable with the idea of only two more hikes this year, a hike in June would suggest the possibility of skipping a hike at the September or December FOMC meeting -- one less stock market negative in the medium term. (To be sure, skipping a hike in December could be offset by the Fed starting to sell off its holdings of government securities then.) Skipping a hike in June because of currently low inflation would be very bullish for stocks, as it would signal that the Fed will be tolerant of strong economic growth for awhile.
Real GDP Growth
Stocks would like to see evidence Real GDP growth will speed up noticeably from its weak 0.7% pace in Q117. Right now, the Fed's models project 1.9% (NY) and 3.6% (Atlanta) for Q217. In truth, not enough data are available as yet to have a reliable forecast for this quarter. So, these model estimates can change. But, the consensus view that GDP Growth will improve from Q117 should continue to support stocks.
Market Complacency
The apparent complacency in the stock market has masked large and offsetting gains and losses among specific companies and industries. There has been significant adjustments in stock prices to fundamental changes at the industry level. So, stock picking has become important. Nevertheless, the complacency -- as seen in the absence of significant volatility in overall measures -- has added to nervousness that the stock market will not be able to maintain its recent rally, particularly with the backdrop of questionable actions by Trump, the slow pace of legislation in Congress, and international hot spots such as North Korea. From a contrarian's perspective, this background is best for a continuation of the rally. A contrarian would worry if most observers don't see any problems.
Washington
Trump's contradictory comments and actions so far have been background noise from a market perspective. While there is a sense among some commentators that Trump's actions and words will undermine US political institutions, this potential result is not close enough to happening to have a noticeable impact on the stock market now. Moreover, although Trump is criticized for switching positions, in some cases, his switch had better implications for the economy than did his original position. This was also the case with the courts' blocking of his anti-immigration order.
The House passage of an ObamaCare repeal has prompted much rancor on the part of Democrats and some support from Republicans. In a sense, both sides won -- Democrats kept a new entitlement program while Republicans succeeded in paring it -- the latter unusual for an entitlement. The legislation has little implication for the overall stock market, except to the extent that its continuing "life" in the Senate will hold back tax reform legislation. Expectations of tax reform, though, remain a positive for stocks -- and the possibility of tax reform argues against any large-scale selling of securities.
The issue of Russian involvement in the election process or the Trump campaign is background noise, as well, unless it leads to impeachment. Ironically, the Russian actions have backfired, inasmuch as no US official will now push for any relaxation of the sanctions without significant concessions by Russia.
One accomplishment by the Trump administration that could have positive benefits for the economy and stock market is the trade agreement with China. This agreement may not have received enough good press. In addition, the pro-business bent of the administration leaves open the possibility of more M&A activity popping up.
Fed Rate Hike
Labor market data have been strong enough to justify a Fed rate hike in June. This has not been the case with inflation data, since the Core CPI and Average Hourly Earnings have slowed on a y/y basis. Fed officials, however, could maintain their view that inflation will speed up ahead as the labor market tightens. So, at this point, the market pricing of an 80% chance of a June Fed rate hike seems reasonable.
If the Fed hikes in June, the stock market could take it in stride if it is viewed as confirmation that the economy is doing well. Moreover, a June hike could ease some concern about future Fed tightening. With some Fed officials comfortable with the idea of only two more hikes this year, a hike in June would suggest the possibility of skipping a hike at the September or December FOMC meeting -- one less stock market negative in the medium term. (To be sure, skipping a hike in December could be offset by the Fed starting to sell off its holdings of government securities then.) Skipping a hike in June because of currently low inflation would be very bullish for stocks, as it would signal that the Fed will be tolerant of strong economic growth for awhile.
Real GDP Growth
Stocks would like to see evidence Real GDP growth will speed up noticeably from its weak 0.7% pace in Q117. Right now, the Fed's models project 1.9% (NY) and 3.6% (Atlanta) for Q217. In truth, not enough data are available as yet to have a reliable forecast for this quarter. So, these model estimates can change. But, the consensus view that GDP Growth will improve from Q117 should continue to support stocks.
Friday, May 5, 2017
April Employment Report Shows Above-Trend Job Growth But With Contained Wage Inflation
The April Employment Report raises the odds of a June Fed rate hike, but is not a slam dunk. The report showed continuing above-trend job growth that is pushing down the Unemployment Rate. It supports the Fed's contention that the Q117 GDP slowdown was temporary. Labor cost inflation, however, is well contained, raising a question whether the Fed's estimate of the level of unemployment that keeps inflation from accelerating is too high. It will be interesting to see if the Fed doves begin to focus on it in their speeches.
This combination of above-trend growth and low wage inflation should be a positive for the profit outlook and thus stocks. It also suggests Treasuries and the dollar should stay in their recent ranges.
The +211k m/m increase in April Payrolls was a decent bounce after the downward-revised +77k in March (was +98k). (The pickup was mainly in services jobs, such as Wholesale Trade, Recreation and Health Care. Retail Jobs rose slightly, as Department Store jobs turned up a bit.) But, the 2-month average is only +144k, leaving open the possibility that the April jump overstates trend. This average is below the averages of both Q416 (+148k) and Q117 (+176k).
The Unemployment Claims data support the idea that job growth is above trend and the possibility that Q217 job growth will exceed the Q117 average. Initial Claims averaged 241k in April, in line with the 244k Q117 average -- indicating that the pace of layoffs was essentially steady last month. Continuing Claims, though, posted their largest m/m decline in more than 2 years, suggesting hiring has picked up. Further declines in Initial or Continuing Claims would point to Payroll growth staying above the Q117 average.
The decline in the Unemployment Rate to 4.4% in April shows that job growth is above trend. The Rate is well below the 4.6% Q117 average, suggesting that Q217 Real GDP Growth is above trend, as well, and possibly posting a large rebound from the weak 0.7% Q117 pace.
Despite the strength of the labor market and real economy, wage inflation remains subdued. While Average Hourly Earnings sped up to +0.3% m/m in April from +0.1% in March, it could be explained by calendar considerations. The y/y was only 2.5%, keeping it well below the 2.9% in December 2016. Note that calendar considerations point to a 0.1% m/m increase in AHE in May, which would lower the y/y to 2.4%.
This combination of above-trend growth and low wage inflation should be a positive for the profit outlook and thus stocks. It also suggests Treasuries and the dollar should stay in their recent ranges.
The +211k m/m increase in April Payrolls was a decent bounce after the downward-revised +77k in March (was +98k). (The pickup was mainly in services jobs, such as Wholesale Trade, Recreation and Health Care. Retail Jobs rose slightly, as Department Store jobs turned up a bit.) But, the 2-month average is only +144k, leaving open the possibility that the April jump overstates trend. This average is below the averages of both Q416 (+148k) and Q117 (+176k).
The Unemployment Claims data support the idea that job growth is above trend and the possibility that Q217 job growth will exceed the Q117 average. Initial Claims averaged 241k in April, in line with the 244k Q117 average -- indicating that the pace of layoffs was essentially steady last month. Continuing Claims, though, posted their largest m/m decline in more than 2 years, suggesting hiring has picked up. Further declines in Initial or Continuing Claims would point to Payroll growth staying above the Q117 average.
The decline in the Unemployment Rate to 4.4% in April shows that job growth is above trend. The Rate is well below the 4.6% Q117 average, suggesting that Q217 Real GDP Growth is above trend, as well, and possibly posting a large rebound from the weak 0.7% Q117 pace.
Despite the strength of the labor market and real economy, wage inflation remains subdued. While Average Hourly Earnings sped up to +0.3% m/m in April from +0.1% in March, it could be explained by calendar considerations. The y/y was only 2.5%, keeping it well below the 2.9% in December 2016. Note that calendar considerations point to a 0.1% m/m increase in AHE in May, which would lower the y/y to 2.4%.
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