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.