Stock Rally Should Not Be Derailed This Week

The stock market may trade cautiously going into this week's two main events -- the Trump/Kim Jong Un Summit (Tuesday) and the FOMC (Wednesday).   But, the rally should not be derailed by them.

While little, if anything, concrete should come out of the summit, both leaders have an incentive to keep the dialogue going.   So, the meeting will likely be termed a success.

With regard to the FOMC Statement, some of the economic description should strengthen from May's, which had focused on the relatively weak Q118.  But, the term "moderate" to describe economic growth will likely remain.  More importantly, there is reason to think the "dots" won't change much either, continuing to indicate expectations of one more 25-BP hike this year (as well as one on Wednesday) -- as the Fed retains its gradual approach to tightening.

The reason to expect little change in the Fed's dots is that economic growth expectations are not out of line with the Fed's Central Tendencies made in March.  The latter call for this year's strength to be followed by a gradual slowing to trend over the following two years.
 
                            Fed's Central Tendency Forecast of Real GDP Growth
                                                  (Q4/Q4 percent change)
                                       2018            2019          2020            Trend
                                       2.6-3.0         2.2-2.6      1.8-2.1          1.8-2.0

Although the Atlanta and NY Fed model forecasts of Q218 Real GDP Growth (4.6% and 3.1%, respectively) are above the Central Tendency expectation for the year, the Q118 pace was below it.   The Fed is focused on the underlying pace, not the quarter-to-quarter wiggles.  For H118, Real GDP Growth is now projected to be 2.7-3.4% -- averaging the NY and Atlanta Fed Q218 projections with the actual 2.2% pace for Q118.  An outcome within the Central Tendency range cannot be ruled out.

The more important question for the Fed is what economic growth will be in H218.  If the Atlanta Fed's Q218 forecast is correct, Real GDP Growth would need to average 2.6% in H218 to hit the upper end of the Central Tendency for the year.  If the NY Fed's forecast is correct, H218 Real GDP Growth would need to be 2.6-3.4% to be within the Central Tendency range.  None of these possibilities can be ruled out.  In any case, Fed officials don't know for sure how economic growth will print either in Q218 or in the rest of the year.  So, they should stay with their plans for gradual monetary policy tightening at least until later this year when the data will indicate slower growth or not.

There are reasons to think Real GDP Growth will slow in the rest of the year.  Some of the Q218 strength is likely a temporary bounce-back from the winter.  The boost from fiscal stimulus should begin to come off.  And, the drag from tighter monetary policy should build.  The NY Fed's model's first projection of Q318 Real GDP is 2.9%.