Fundamentals Look Good For Stocks in Rest of August, Treasuries Too?

The fundamentals look stock-market friendly for the rest of August -- which could limit if not offset the market's seasonal weakness this month.   US economic data should ratify moderately strong growth.   A 0.2% m/m consensus print for the July Core CPI, due Friday, looks reasonable, while a lower print cannot be ruled out.  Even if the Core CPI prints above consensus, it could be attributable to temporary boosts from tariffs or higher oil prices.  None of the data should persuade the Fed to depart from its gradual approach to tightening.  And, the trade disputes with Mexico, Canada and the EU may become tailwinds, as their resolutions look more and more likely.  The next steps in the trade dispute with China are known and won't be put into effect until September at the earliest.

The 0.2% consensus estimate for the July Core CPI looks reasonable.  But a lower print cannot be ruled out, as the impact of tariffs may have peaked.   Motor vehicle prices already rose sharply in May and June.   And, household appliance prices slowed sharply in June after a couple of months of large increases.  

Treasuries could be helped over the month by a ratcheting down in the Atlanta Fed model's projection of Q318 Real GDP Growth.   After last Friday's July Employment Report, the model's forecast was cut to 4.4% (q/q, saar) from 5.0%,.  But, it still looks too high relative to Payrolls and Total Hours Worked that month.  So, the risk is that the forecast will be trimmed further to under 4.0% as more data come in.

Some Street economists have been warning that the huge Federal Deficit will steepen the Treasury curve in H18.   I'm not so sure.  The last piece of research I had done at the New York Fed (in 1985), together with another economist, expanded the Fed model's term structure equation to include the Federal Deficit.  We found that it was the expected Deficit over the following 4 quarters, as projected by the CBO, that mattered.  If this is correct, the impact of the higher Deficit into 2019 already should be embodied in longer-term yields.  The fact that yields have not risen much probably reflects offsets from other factors, such as the stronger dollar. 

The risk to Treasuries may very well be a weaker dollar in H218.   The resolution of the trade disputes could be the catalyst behind a decline in the dollar.   This would be the case if its recent strength reflected expectations of a smaller trade deficit resulting from US tariffs.




 Follow me on Twitter at @cjslyce.   I may comment on just-released US economic data or other market developments.