This week's US economic data should confirm moderate economic growth with little inflationary pressures in early Q317. The data will likely have little impact on stocks or Treasuries, although the evidence suggests a bullish tilt. While the evidence is mixed, and the best evidence missed last month, some payback for last month's miss is conceivable -- which would suggest softer-than-consensus prints for Mfg ISM and Payrolls. Also, some evidence raises the risk of an uptick in the Unemployment Rate. Average Hourly Earnings risks printing high on a m/m basis, but steady in the more important y/y.
Evidence regarding the direction of the m/m change in the July Mfg ISM is neither one-sided nor reliable. Monday's release of the July Chicago PM Index is expected to show a decline. The Chicago PM correctly predicted direction of the Mfg ISM in the past two months, but it has a mixed record in prior months this year as well as in the past two years' July. The Dallas Fed Mfg Index is due Monday, as well. Even if the Mfg ISM falls in July, however, the level should remain in the mid-50's, signaling strong manufacturing activity. The level was 57.8 in June.
(m/m change, points)
Mfg ISM Phil Fed Mfg Dallas Fed Mfg Richmond Fed Mfg
Jan17 +1.3 +2.1 +6.6 +4
Feb +1.7 +19.7 +2.4 +5
Mar -0.5 -10.5 -7.6 +5 x
Apr -2.4 -10.8 -0.1 -2
May +0.1 +16.8 +0.4 -19 x
Jun +2.9 -11.2 x -2.2 x +6
Jul na -8.1 na +7
Initial Claims did not correctly predict the speedup in June Private Payrolls. They suggest little speedup or slowdown in July's m/m change from June's +187k m/m, consistent with the consensus estimate of +180k. But, with Continuing Claims rising further in July, the risk is that Payrolls could slow by more than expected by consensus. Continuing rose 16k m/m in July, after climbing 29k in June.
The increase in Continuing Claims also raises the risk of a counter-consensus uptick in the Unemployment Rate to 4.5% from 4.4% in June. Consensus is for a decline to 4.3%. The m/m change in Continuing has correctly predicted the m/m direction of the Unemployment Rate each month so far this year.
(m/m change)
Continuing Claims (000s) Unemployment Rate (% pt)
Jan17 +2 +0.1
Feb -10 -0.1
Mar -41 -0.2
Apr -47 -0.1
May -60 -0.1
Jun +29 +0.1
Jul to-date +16 na
The ADP Estimate, on Wednesday, could be pulled up by the high June Payroll print -- just as the June ADP Estimate looks to have been pulled down by the weak May Payroll print. So, it may exaggerate the strength of July Payrolls. But, there is mixed evidence from the past few years regarding whether ADP tends to overestimate or underestimate Payrolls in July.
2nd Difference in
Initial Claims Private Payrolls (First Print)
Jan17 -19k +97k
Feb +2 -10
Mar +29 -138
Apr -29 +105
May +7 -47
Jun +3 +40 x
Jul-to-date 0 na
Average Hourly Earnings risk printing on the high side in July because of calendar considerations. A consensus-like 0.3% m/m increase, however, would keep the y/y steady at 2.4% -- showing no pickup in inflationary wage pressures.
Sunday, July 30, 2017
Friday, July 28, 2017
Today's Key Reports Confirm Moderate Real Growth With Little Inflation
Today's two important reports -- Q217 Real GDP and Employment Cost Index -- confirm the continuation of moderate economic growth with little inflationary pressures. They are not likely to change officials' views -- both dovish and hawkish -- within the Fed. But, if this combination continues in upcoming July-August data, it is conceivable that the Fed could keep the funds rate steady but commence balance sheet reduction at the September FOMC meeting (possibly hinted at in this week's FOMC Statement that "the Committee expects to begin implementing its balance sheet normalization program relatively soon.")
The 2.6% Q217 Real GDP showed the expected bounce-back from the soft 1.2% Q117 pace (revised down from 1.4%). Economic growth in H117 was 1.9% -- about the same as the 1.8% 2016 growth rate (Q4/Q4) and in line with the Fed's longer-run 1.8-2.0% central tendency. The most interesting components of Q217 GDP were the further strong showing of Business Fixed Investment (2nd strong quarter in a row and possibly helped by pro-growth attitude of the Trump Administration) and another quarter of negligible Inventory Investment (possibly reflecting the shift away from brick and mortar retailing -- a stealth factor holding down economic growth). In addition, the underlying inflation measures were very soft, particularly with the Core PCE Deflator slowing to 0.9% (q/q, saar) and the Market-Based Core PCE Deflator to 0.2%.
The absence of inflationary pressures was evident in the Q217 Employment Cost Index, as well. The ECI slowed to 0.5% (q/q) from 0.8% in Q117 -- even excluding jobs with a commission component (0.5% from 0.9%). The y/y was steady at a moderate 2.4%.
The 2.6% Q217 Real GDP showed the expected bounce-back from the soft 1.2% Q117 pace (revised down from 1.4%). Economic growth in H117 was 1.9% -- about the same as the 1.8% 2016 growth rate (Q4/Q4) and in line with the Fed's longer-run 1.8-2.0% central tendency. The most interesting components of Q217 GDP were the further strong showing of Business Fixed Investment (2nd strong quarter in a row and possibly helped by pro-growth attitude of the Trump Administration) and another quarter of negligible Inventory Investment (possibly reflecting the shift away from brick and mortar retailing -- a stealth factor holding down economic growth). In addition, the underlying inflation measures were very soft, particularly with the Core PCE Deflator slowing to 0.9% (q/q, saar) and the Market-Based Core PCE Deflator to 0.2%.
The absence of inflationary pressures was evident in the Q217 Employment Cost Index, as well. The ECI slowed to 0.5% (q/q) from 0.8% in Q117 -- even excluding jobs with a commission component (0.5% from 0.9%). The y/y was steady at a moderate 2.4%.
Sunday, July 23, 2017
Next Week's FOMC Meeting and More
The FOMC Meeting on Tuesday and Wednesday will hold the markets' attention next week, as well as a slew of corporate earnings and some US economic data. The markets will be looking to see if the FOMC Statement shifts dovishly with a greater emphasis on the absence of inflationary evidence, as did Yellen's Semi-Annual Monetary Policy Testimony (and ECB President Draghi's press conference). The markets could be mildly disappointed, however, as the key parts of the June FOMC Statement do not have to be changed to accommodate Yellen's dovish tilt -- and at the same time to accommodate the hawkish views of other FOMC members. Moreover, keeping the same language as in June would allow the Fed to retain flexibility while it awaits July-August data. Nonetheless, US economic data that print near consensus estimates on Friday -- Q2 Real GDP and Employment Cost Index -- should sustain the rallies in stocks and Treasuries.
The key parts to watch in the FOMC Statement, from the June Statement, are:
First paragraph:
"On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance."
Second paragraph:
"Inflation on a 12- month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term."
Fourth paragraph:
"The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal."
"The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
The final assessment of the July FOMC Statement will likely leave the odds of a September Fed rate hike little changed. Market commentary will probably highlight the importance of the upcoming July and August CPI in the September rate decision. My early thoughts are for the July Core CPI to show a steady 1.7% y/y, leaving the issue unresolved (see my prior blog).
As for this coming week's key US economic data, consensus looks for 2.6% (q/q, saar) Q2 Real GDP and 0.6% q/q Employment Cost Index. If correct, they would indicate moderate economic growth and steady labor cost inflation. /1/ Q217 Real GDP Growth would exceed the Fed's 1.8-2.0% central tendency, but, combined with the below-trend 1.4% Q117 pace, would put growth over H117 at 2.0%. Note that the NY Fed and Atlanta Fed models' estimates for Q217 Real GDP are 2.0% and 2.5%, respectively. While softer than consensus, they still show moderate growth. All these forecasts can change in response to data released before Friday. /2/ The y/y for the ECI would be 2.4% -- in line with increases seen in other labor cost measures. Such prints should not change the odds of a September Fed rate hike significantly.
Economic growth looks to be remaining moderate in early Q317. The NY Fed model's early projection is 2.0%. And, the decline in last week's Initial Claims to 233k raises the possibility that growth may be picking up from late Spring. It will be important to see if Claims stay low in Thursday's report. If they do, the risk would be for forecasts of Q317 Real GDP to trend upwards.
The key parts to watch in the FOMC Statement, from the June Statement, are:
First paragraph:
"On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance."
Second paragraph:
"Inflation on a 12- month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term."
Fourth paragraph:
"The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal."
"The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
The final assessment of the July FOMC Statement will likely leave the odds of a September Fed rate hike little changed. Market commentary will probably highlight the importance of the upcoming July and August CPI in the September rate decision. My early thoughts are for the July Core CPI to show a steady 1.7% y/y, leaving the issue unresolved (see my prior blog).
As for this coming week's key US economic data, consensus looks for 2.6% (q/q, saar) Q2 Real GDP and 0.6% q/q Employment Cost Index. If correct, they would indicate moderate economic growth and steady labor cost inflation. /1/ Q217 Real GDP Growth would exceed the Fed's 1.8-2.0% central tendency, but, combined with the below-trend 1.4% Q117 pace, would put growth over H117 at 2.0%. Note that the NY Fed and Atlanta Fed models' estimates for Q217 Real GDP are 2.0% and 2.5%, respectively. While softer than consensus, they still show moderate growth. All these forecasts can change in response to data released before Friday. /2/ The y/y for the ECI would be 2.4% -- in line with increases seen in other labor cost measures. Such prints should not change the odds of a September Fed rate hike significantly.
Economic growth looks to be remaining moderate in early Q317. The NY Fed model's early projection is 2.0%. And, the decline in last week's Initial Claims to 233k raises the possibility that growth may be picking up from late Spring. It will be important to see if Claims stay low in Thursday's report. If they do, the risk would be for forecasts of Q317 Real GDP to trend upwards.
Sunday, July 16, 2017
Stock and Treasury Market Rallies Should Continue into Early August, But...
The stock and Treasury market rallies, after Yellen's dovishly tilted testimony and the low June CPI, probably have more to go. In the next few weeks, strong Q217 corporate profits reports should sustain the stock market rally, while a further unwinding of the prior run-up in longer-term yields (which was prompted by hawkish central bank- speak) should be supported by signs of non-inflationary US economic growth. But, the question of whether the Fed will or will not hike in September should remain an open question. There will be two more months of US economic data available (for July and August) before the September 19-20 FOMC meeting, which could raise the odds of a hike. Indeed, my early thoughts are that they may not be soft enough to derail the Fed from its plan of gradual tightening, including a rate hike in September and the start of balance sheet reduction in December. So, I remain cautious about the stock market in the August-September period.
The most important US economic data in the rest of July are the first report on Q217 Real GDP Growth and the June PCE Deflator. The Atlanta Fed's model has been cutting its forecast for Q217 Real GDP and is now down to 2.5% (q/q, saar). The NY Fed's model remains at 1.9%. This would put the GDP growth rate for H117 1.7-2.0%, in line with the Fed's longer-term central tendency (1.8-2.0%) and not weak enough to derail the Fed from its tightening path.
Early projections are for near-trend growth to continue in Q317. The NY Fed's model projects 1.8% -- in line with the Fed's central tendency but slower than the Q217 pace. Some of the Q2 strength was just a bounce-back from weather-related softness in Q117 and should stop boosting growth in Q317. For example, consumer spending on utilities was weak in Q17 because of the warm winter, and just rebounded toward normal in Q217. This rebound should dissipate in Q317. Inventory investment should add less to growth in Q317 than in Q217 when it partially reversed a sharp drop in Q117. I continue to think that efficiencies in inventory as a result of the shift to internet shopping will be a factor holding down GDP Growth in the near future.
Upcoming inflation data should be mixed. The June PCE Deflator should be soft, as was the CPI. The y/y should remain at 1.4%, assuming no revisions to prior months But, calendar considerations raise the risk of a high 0.3% m/m in July Average Hourly Earnings. Nonetheless, the y/y would remain at 2.5%, again assuming no revisions to prior months.
Early thoughts on the July Core CPI suggest a steady 1.7% y/y at best. This would require a low 0.1% m/m. There are mixed considerations. For example, Internet competition and bi-monthly sampling argue for another decline in apparel prices, but there could be less-than-seasonal discounting this month after a lot of discounting occurred during the Spring.
Although Yellen has been downplaying the recently low Core CPI, saying that it resulted from one-off price drops (such as in wireless telephone services) or the pass-through of the decline in oil prices, she is overstating the case. The slowdown in inflation is broader-based. In particular, owners' equivalent rent, a major component of the CPI, slowed to a annualized pace of 2.8% over H117 from 3.6% over 2016 -- subtracting 0.2% pt from the annualized Core CPI inflation rate.
The most important US economic data in the rest of July are the first report on Q217 Real GDP Growth and the June PCE Deflator. The Atlanta Fed's model has been cutting its forecast for Q217 Real GDP and is now down to 2.5% (q/q, saar). The NY Fed's model remains at 1.9%. This would put the GDP growth rate for H117 1.7-2.0%, in line with the Fed's longer-term central tendency (1.8-2.0%) and not weak enough to derail the Fed from its tightening path.
Early projections are for near-trend growth to continue in Q317. The NY Fed's model projects 1.8% -- in line with the Fed's central tendency but slower than the Q217 pace. Some of the Q2 strength was just a bounce-back from weather-related softness in Q117 and should stop boosting growth in Q317. For example, consumer spending on utilities was weak in Q17 because of the warm winter, and just rebounded toward normal in Q217. This rebound should dissipate in Q317. Inventory investment should add less to growth in Q317 than in Q217 when it partially reversed a sharp drop in Q117. I continue to think that efficiencies in inventory as a result of the shift to internet shopping will be a factor holding down GDP Growth in the near future.
Upcoming inflation data should be mixed. The June PCE Deflator should be soft, as was the CPI. The y/y should remain at 1.4%, assuming no revisions to prior months But, calendar considerations raise the risk of a high 0.3% m/m in July Average Hourly Earnings. Nonetheless, the y/y would remain at 2.5%, again assuming no revisions to prior months.
Early thoughts on the July Core CPI suggest a steady 1.7% y/y at best. This would require a low 0.1% m/m. There are mixed considerations. For example, Internet competition and bi-monthly sampling argue for another decline in apparel prices, but there could be less-than-seasonal discounting this month after a lot of discounting occurred during the Spring.
Although Yellen has been downplaying the recently low Core CPI, saying that it resulted from one-off price drops (such as in wireless telephone services) or the pass-through of the decline in oil prices, she is overstating the case. The slowdown in inflation is broader-based. In particular, owners' equivalent rent, a major component of the CPI, slowed to a annualized pace of 2.8% over H117 from 3.6% over 2016 -- subtracting 0.2% pt from the annualized Core CPI inflation rate.
Wednesday, July 12, 2017
Yellen's Testimony Dovishly Tilted
Yellen's written monetary policy testimony is dovishly tilted . She did not diverge from previous Fedspeak about only gradually raising the funds rate and reducing the Fed's balance sheet. But, she emphasized points made by Fed Governor Brainard: /1/ that the neutral level of the funds rate is likely low, so not much more tightening is needed, and /2/ that the Fed's main concern is the low inflation rate. Her testimony should be a positive for prices of stocks and Treasuries. It also suggests that Friday's report on the June CPI is the next important US economic data release.
Brainard, in a speech yesterday, reiterated that she views the "real" level of the neutral funds rate at close to 0.0%. Adding on the Fed's 2% inflation target would put the "nominal" neutral funds rate at 2.0%. With the current PCE Deflator inflation rate at 1.4% (y/y), the nominal neutral funds rate presumably is below 2.0% -- not far above the current 1.0-1.25% funds rate range.
Yellen said regarding the near-term neutral funds rate:
"That expectation is based on our view that the federal funds rate remains somewhat below its neutral level--that is, the level of the federal funds rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel. Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance. "
She left open a higher neutral rate in the longer term:
"But because we also anticipate that the factors that are currently holding down the neutral rate will diminish somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2 percent goal. Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades."
Yellen emphasized a very modest beginning of balance sheet reduction:
"The Committee intends to gradually reduce the Federal Reserve's securities holdings by decreasing its reinvestment of the principal payments it receives from the securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps. Initially, these caps will be set at relatively low levels to limit the volume of securities that private investors will have to absorb. The Committee currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the program this year."
Yellen said regarding inflation:
"It appears that the recent lower readings on inflation are partly the result of a few unusual reductions in certain categories of prices; these reductions will hold 12-month inflation down until they drop out of the calculation. Nevertheless, with inflation continuing to run below the Committee's 2 percent longer-run objective, the FOMC indicated in its June statement that it intends to carefully monitor actual and expected progress toward our symmetric inflation goal."
Brainard, in a speech yesterday, reiterated that she views the "real" level of the neutral funds rate at close to 0.0%. Adding on the Fed's 2% inflation target would put the "nominal" neutral funds rate at 2.0%. With the current PCE Deflator inflation rate at 1.4% (y/y), the nominal neutral funds rate presumably is below 2.0% -- not far above the current 1.0-1.25% funds rate range.
Yellen said regarding the near-term neutral funds rate:
"That expectation is based on our view that the federal funds rate remains somewhat below its neutral level--that is, the level of the federal funds rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel. Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance. "
She left open a higher neutral rate in the longer term:
"But because we also anticipate that the factors that are currently holding down the neutral rate will diminish somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2 percent goal. Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades."
Yellen emphasized a very modest beginning of balance sheet reduction:
"The Committee intends to gradually reduce the Federal Reserve's securities holdings by decreasing its reinvestment of the principal payments it receives from the securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps. Initially, these caps will be set at relatively low levels to limit the volume of securities that private investors will have to absorb. The Committee currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the program this year."
Yellen said regarding inflation:
"It appears that the recent lower readings on inflation are partly the result of a few unusual reductions in certain categories of prices; these reductions will hold 12-month inflation down until they drop out of the calculation. Nevertheless, with inflation continuing to run below the Committee's 2 percent longer-run objective, the FOMC indicated in its June statement that it intends to carefully monitor actual and expected progress toward our symmetric inflation goal."
Friday, July 7, 2017
The June Employment Report and FOMC Minutes Keep Open Fed Tightening Ahead
The June Employment Report has evidence that can be used by both hawks and doves at the Fed. For hawks, the bounce-back in Payrolls and uptick in the Average Workweek argue for continued good economic growth in Q317. For doves, the higher Unemployment Rate and soft Average Hourly Earnings argue that weak inflation pressures allow for stronger growth. Nonetheless, Fed officials appear intent on following through with their plan for raising the funds rate another 25 BPs this year and beginning to roll off maturing securities from the Fed's balance sheet. This will probably be a major point in Yellen's semi-annual monetary policy testimony next week -- a negative for both stocks and Treasuries.
The June FOMC Minutes focused on the start-date for rolling off maturing securities, with some officials arguing for September while others arguing for a later date. While there also was discussion on the potential impact of balance sheet reduction on financial markets, it did not seem as if most Fed officials think it will be large. Indeed, there was discussion why the rate hikes so far have resulted in easier financial market conditions -- a point likely raised by NY Fed President Dudley, who emphasized this relationship in a recent speech (see my blog on March 31).
There are two points worth noting with regard to these two discussions. First, Fed officials are emphasizing the "flow" perspective on Fed balance sheet reduction, arguing that a modest quarterly pace would have little impact on financial markets. However, when Fed staff analyzed the likely impact of Quantitative Easing several years ago, it concluded that the "stock" effect of the announcement was more important than the flow effect of the pace of long-term asset purchases. In other words, announcing a $120 Bn amount of purchases over a year had a larger impact on financial markets than the $10 Bn monthly purchase. If this conclusion is correct, the risk is that the announcement of $2Tn reduction in the Fed's balance sheet over the next several years may very well be a large negative for the markets, even though the pace is modest.
Second, Fed officials' puzzlement over the easing of financial market conditions after their rate hikes shows that they do not view the markets from an "optimal control" perspective as I do (see my blog on May 29). (From this perspective, markets move in ways to achieve the Fed's targets, which means they would work to offset the restrictive impact of the higher funds rate since the Fed did not want to slow the economy.) As a result, officials may interpret the easier conditions to mean the Fed can tighten more aggressively. However, the June minutes highlighted a discussion that changes the Fed's objectives. There was "concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability." This objective -- to prevent a buildup of risks for financial stability -- works against market actions to offset the restrictiveness of a tightening at the short end of the Treasury market. In particular, the new objective is a problem for the stock market, since it means the economy is more likely to feel the negative effects of the Fed tightening.
The June FOMC Minutes focused on the start-date for rolling off maturing securities, with some officials arguing for September while others arguing for a later date. While there also was discussion on the potential impact of balance sheet reduction on financial markets, it did not seem as if most Fed officials think it will be large. Indeed, there was discussion why the rate hikes so far have resulted in easier financial market conditions -- a point likely raised by NY Fed President Dudley, who emphasized this relationship in a recent speech (see my blog on March 31).
There are two points worth noting with regard to these two discussions. First, Fed officials are emphasizing the "flow" perspective on Fed balance sheet reduction, arguing that a modest quarterly pace would have little impact on financial markets. However, when Fed staff analyzed the likely impact of Quantitative Easing several years ago, it concluded that the "stock" effect of the announcement was more important than the flow effect of the pace of long-term asset purchases. In other words, announcing a $120 Bn amount of purchases over a year had a larger impact on financial markets than the $10 Bn monthly purchase. If this conclusion is correct, the risk is that the announcement of $2Tn reduction in the Fed's balance sheet over the next several years may very well be a large negative for the markets, even though the pace is modest.
Second, Fed officials' puzzlement over the easing of financial market conditions after their rate hikes shows that they do not view the markets from an "optimal control" perspective as I do (see my blog on May 29). (From this perspective, markets move in ways to achieve the Fed's targets, which means they would work to offset the restrictive impact of the higher funds rate since the Fed did not want to slow the economy.) As a result, officials may interpret the easier conditions to mean the Fed can tighten more aggressively. However, the June minutes highlighted a discussion that changes the Fed's objectives. There was "concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability." This objective -- to prevent a buildup of risks for financial stability -- works against market actions to offset the restrictiveness of a tightening at the short end of the Treasury market. In particular, the new objective is a problem for the stock market, since it means the economy is more likely to feel the negative effects of the Fed tightening.
Sunday, July 2, 2017
Outlook for the Stock Market, Fed and Next Week's Key US Economic Data
The downside risks in the stock market outlook came to the fore sooner than expected last week. Central bankers highlighted the potential to tighten monetary policy in the US, Canada and Europe later this year, while the Senate's failure to pass a health care bill lowered expectations of corporate tax reform. These developments more than offset the positive effects of strong earnings by some companies. These countervailing forces are likely to continue to buffet the stock market in coming weeks. However, a renewed modest uptrend in stocks into July is conceivable, as Fed fears are tempered somewhat by softer-than-consensus US economic data next week and as more reports of strong earnings are released in the rest of the month.
Evidence points to softer-than-consensus June Mfg ISM (due Monday) and Payrolls (due Friday). The two regional surveys that have correctly predicted the m/m direction of the Mfg ISM each month so far this year are the Phil Fed Mfg Index and the Dallas Fed Mfg Index. Both point to a decline, contrary to the consensus expectation of an increase to 55.1 from 54.9 in May.
(m/m change, points)
Mfg ISM Phil Fed Mfg Dallas Fed Mfg
Jan17 +1.3 +2.1 +6.6
Feb +1.7 +19.7 +2.4
Mar -0.5 -10.5 -7.6
Apr -2.4 -10.8 -0.1
May +0.1 +16.8 +0.4
Jun na -11.2 -2.2
June Payrolls risk slowing further, based on evidence from Initial Unemployment Claims. The second difference in Initial Claims rose in June, signaling a weaker June print than May's. A slowdown would be contrary to the consensus expectation of a speedup to +177k m/m from +138k in May.
2nd Difference in
Initial Claims Private Payrolls (First Print)
Jan17 -19k +97k
Feb +2 -10
Mar +29 -138
Apr -29 +105
May +7 -47
Jun-to-date +2 na
Both the June Mfg ISM and Payrolls should still be strong enough to keep a September Fed rate hike in play. But, it might encourage the dovish Fed officials to continue to raise questions about the wisdom to stay on a tightening path at this time. These doves are not likely to prevail at the FOMC, however, as Fed officials appear to be committed to their "normalization" path of the Fed funds rate. Indeed, the banks' passage of their stress tests removed a concern about further tightening. So, only very weak evidence will likely be required to dissuade them from a September rate hike. Fed officials have said that they view Payroll gains of 75-125k in a month to be consistent with a steady Unemployment Rate. Payrolls presumably would need to print below this range to be viewed as weak.
While Fed officials are likely to emphasize that the funds rate (and Fed balance sheet) remain at accommodative levels at this stage in the normalization process, this does not undo the problematic implications of funds rate normalization for a number of asset classes, including stocks, houses, artwork, etc. Normalization would likely weigh on these asset classes to the extent that they had benefited from the prior near-zero level of the funds rate. In other words, these asset classes would "normalize" also. So, I continue to think that August-September -- after the Q217 earnings season and before the Fed rate decision -- is the real window for a major correction in the stock market. It may take a major stock market correction to keep the Fed from hiking at the September FOMC Meeting.
The one caveat is that signs of progress on corporate tax reform could allow the stock market to escape an August-September correction. Expectations of a boost to economic growth from a corporate tax rate cut would take the place of the disappearing Fed stimulus. To some extent, Trump's reversal of regulations already may be helping.
Evidence points to softer-than-consensus June Mfg ISM (due Monday) and Payrolls (due Friday). The two regional surveys that have correctly predicted the m/m direction of the Mfg ISM each month so far this year are the Phil Fed Mfg Index and the Dallas Fed Mfg Index. Both point to a decline, contrary to the consensus expectation of an increase to 55.1 from 54.9 in May.
(m/m change, points)
Mfg ISM Phil Fed Mfg Dallas Fed Mfg
Jan17 +1.3 +2.1 +6.6
Feb +1.7 +19.7 +2.4
Mar -0.5 -10.5 -7.6
Apr -2.4 -10.8 -0.1
May +0.1 +16.8 +0.4
Jun na -11.2 -2.2
June Payrolls risk slowing further, based on evidence from Initial Unemployment Claims. The second difference in Initial Claims rose in June, signaling a weaker June print than May's. A slowdown would be contrary to the consensus expectation of a speedup to +177k m/m from +138k in May.
2nd Difference in
Initial Claims Private Payrolls (First Print)
Jan17 -19k +97k
Feb +2 -10
Mar +29 -138
Apr -29 +105
May +7 -47
Jun-to-date +2 na
Both the June Mfg ISM and Payrolls should still be strong enough to keep a September Fed rate hike in play. But, it might encourage the dovish Fed officials to continue to raise questions about the wisdom to stay on a tightening path at this time. These doves are not likely to prevail at the FOMC, however, as Fed officials appear to be committed to their "normalization" path of the Fed funds rate. Indeed, the banks' passage of their stress tests removed a concern about further tightening. So, only very weak evidence will likely be required to dissuade them from a September rate hike. Fed officials have said that they view Payroll gains of 75-125k in a month to be consistent with a steady Unemployment Rate. Payrolls presumably would need to print below this range to be viewed as weak.
While Fed officials are likely to emphasize that the funds rate (and Fed balance sheet) remain at accommodative levels at this stage in the normalization process, this does not undo the problematic implications of funds rate normalization for a number of asset classes, including stocks, houses, artwork, etc. Normalization would likely weigh on these asset classes to the extent that they had benefited from the prior near-zero level of the funds rate. In other words, these asset classes would "normalize" also. So, I continue to think that August-September -- after the Q217 earnings season and before the Fed rate decision -- is the real window for a major correction in the stock market. It may take a major stock market correction to keep the Fed from hiking at the September FOMC Meeting.
The one caveat is that signs of progress on corporate tax reform could allow the stock market to escape an August-September correction. Expectations of a boost to economic growth from a corporate tax rate cut would take the place of the disappearing Fed stimulus. To some extent, Trump's reversal of regulations already may be helping.
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