Fighting Fiscal Stimulus on Back Burner For Now?

The stock and Treasury markets may be able to put the need to offset fiscal stimulus on the "back burner"for the next few weeks.   This is because economic growth may be moderating.   As a result, stocks can continue to recover from the recent one-week plunge (market still about 3% below the end-of-January highs) and longer-term Treasury yields can ease back further.  The Fed should retain its gradual approach to tightening.

A slowdown in economic growth is one of the 3 reasons that could eliminate the need for the markets to "crowd out" private spending in order to make room for the boost from tax cuts,  increased government spending, and effects of tariffs  (see my February 11 blog).  A moderation in economic growth also means that the pickup in inflation seen in January can be tolerated in case it turns out to be temporary. 

Both Manufacturing Production (part of Industrial Production) and Ex Auto/Ex Gasoline Retail Sales have slowed sharply in the past 2-3 months.  The slowdowns may be just pauses after good-sized gains in the prior few months.  Nevertheless, forecasts of Q118 Real GDP have come down.   The Atlanta and NY Fed models now project about 3.2% (down from about 4.0%), and some Street Economists look for sub-3.0% growth.  Nonetheless, this pace is above the 1.2% Q117 Real GDP growth rate, so it would be a positive for Q118 corporate earnings (due in April).

The Claims data also hint at moderation.  While Initial Claims are back to their recent lows, Continuing Claims turned up last month.  These data suggest few layoffs, but slower re-hiring.

                                        Unemployment Insurance Claims
                                              Initial                 Continuing
     Oct                                   232k                   1.893 Mn
     Nov                                  242                     1.914
     Dec                                  241                     1.911

     Jan                                   233                     1.948
     Feb --1st wk                     230                      na

Although both the CPI and PPI were high in January, they should not be enough to push the Fed to a more aggressive stance in monetary policy.   Some of the culprits behind the inflation jumps are likely to ease off in the next month or so.  And, the y/y is still below the Fed's 2.0% target.  Furthermore, the longer-term inflation expectations in the Mid-February University of Michigan Consumer Sentiment Survey were steady.  And, there is a good chance Average Hourly Earnings will soften in February.

This week's Fed speakers will likely emphasize their gradual approach to tightening, without being specific about the number of hikes this year.  From their perspective, the normalization of monetary policy, with its attendant tightening, covers not only hikes in the Fed funds rate but also the reduction in the Fed's balance sheet.  In a sense, the Fed is trying not to normalize not only the level of short-term rates but also the steepness of the yield curve.   The Fed sees the funds rate normalizing to 2.8-3.0% in 2019 from the current 1.5%.  The 10-/2-year Treasury yield spread, currently about 0.7% pt, is well below the 1.2-2.75% range seen between 2010 and 2014.  So,  monetary policy has more room to normalize while still being supportive of economic growth.