This Week's Key US Economic Data

Key US economic data are expected to add to evidence that the worst of the slowdown is behind us.  Consensus-like prints could boost expectations for Q219 Real GDP Growth.  However, the evidence regarding these data is mixed.  For example, the effects of bad weather could muddy next week's key US economic data -- March Retail Sales, Mfg ISM and Employment Report.   It may take a couple more months to get a clearer picture of the economy's underlying strength or weakness.  Meanwhile, stocks act as if they expect stronger growth ahead, while Treasuries behave as if they expect weaker growth.

One way to rationalize the apparently divergent outlooks of the stock and Treasury markets is from an optimal control perspective.   Since the Fed said it would like to see economic growth and inflation pick up, both markets are moving in ways that serve this goal.  If the economic data become more in line with the Fed's targets, they would be negatives for stocks and Treasuries.  Both markets would not have to work as hard to achieve the Fed's goals.

Macroeconomic Evidence
Evidence continues to build showing that the worst of the economic slowdown is behind us.  Initial Claims fell back to their low range in the latest report.  The Atlanta Fed model's projection of Q119 Real GDP Growth is now up to 1.7%, well above its initial 0.5% estimate.   And, the ECRI Leading Index jumped in the week ended March 22, despite the stock market's decline that week (see chart below).  The Index is now up in each of the latest 6 weeks.  

This week's key US economic data have mixed risks.  Consensus looks for +0.4% m/m for February Ex Auto Retail Sales, a decent gain after the December/January volatility.  But, bad weather could weigh on sales.  While regional manufacturing surveys were mixed for March, the most reliable predictor of the Mfg ISM -- the Richmond Fed Mfg Index -- rose.   An increase in the Mfg ISM would be stronger than the steady 54.2 consensus estimate.  However, I wonder whether there is downside risk from Larry Kudlow's comment on Friday that the Fed should cut the funds rate "immediately" by 50 BP.   He may have had advance notice of the Mfg ISM, and a decline (maybe to under 50.0) could have been the trigger behind his comment.

Consensus has March Payrolls recovering to +170k m/m, close to the January-February average (+166k) after the weather-depressed +20k in February.  It is still below the +223k 2018 m/m average.  Nevertheless, there may be downside risk to consensus, since many parts of the country saw bad weather in the March Payroll Survey Week.  The Unemployment Rate tends to be less affected by bad winter weather than are Payrolls.  Consensus looks for a steady 3.8%.  Such a print would put the Q119 average at 3.9%.  This would be up from 3.8% in Q418 and suggest below-trend Real  GDP Growth in Q119.  Consensus also expects +0.3% m/m in Average Hourly Earnings.  This above-trend estimate is consistent with calendar considerations.  But, the risk is for a lower-than-consensus print, reflecting an unwinding of composition effects that seemed to boost AHE by 0.1% pt in February.

Q119 Corporate Earnings
Stocks will face Q119 corporate earnings reports in a few weeks.  They are expected to be down 1.9% y/y, although they have tended to exceed expectations in recent quarters.   Even if they post a gain, the latter should be modest and well below the double-digit increases seen last year.  The most interesting new information will be whether companies see the slowdown persisting.

Inflation Risks
Inflation is not a problem now.   The Core PCE Deflator's y/y fell to 1.8% in January from 1.9% in December.   But, this disinflation could reverse if economic growth picks up this Spring.   It is noteworthy that the University of Michigan's long-term 5-year inflation expectations measure rebounded to 2.5% in March from 2.3% in February. 

ECRI Leading Index (level)

Yield Curve Inverts, But Incipient Signs That Worst of the Slowdown is Behind Us

The markets finally appear to be reacting to the global economic slowdown.  Both the stock and Treasury markets had large moves in response to the drop in the German Market Purchasing Managers Index.  In particular, the 10-year/3-month Treasury yield spread turned negative -- the first time this curve "inverted" since 2006.  Some commentators have highlighted the conventional view that an inverted yield curve typically precedes a recession. 

The conventional view may be too dire now.  The globalization of the financial markets may have made US markets more sensitive to European and Asian economies than in the past.  Investment flows move quickly across borders to "capture" yield.  The decline in the German bond yield to a negative level last week likely prompted a shift out of them into Treasuries.  Even without considering the effects of globalization, history shows the lead time from the start of an inverted Treasury yield curve and  recession to have been mostly over one year:

                                                   Starting Month
                 10-year/3-month Tsy Yield Curve                Recession             Lead Time            
                          Inversion                                                                 (# of months)
                          June 89                                                   Jul 90                    13
                          Jul 00                                                    Mar 01                     8
                         Mul 06                                                   Dec 07                   18

Ironically, evidence is beginning to creep in suggesting the worst of the US economic slowdown may be behind us.  Both Initial and Continuing Claims are below their recent peaks, the March Phil Fed Mfg Index turned positive, and February Existing Home Sales rebounded sharply.
To be sure, some of the factors behind the US slowdown -- bad weather, weak export demand, year-end Fed tightening -- still can exert downward pressure on the economy, and it may not be until well into the Spring to get a clearer picture of faster growth.  So, stocks are still vulnerable for a further pullback, particularly with Q119 corporate earnings soon to be reported.  And, longer-term Treasury yields could fall by more, further inverting the curve. 

But, the markets may find themselves to have overshot later this Spring.  Both the ECRI Leading Index and the Atlanta Fed Model forecast have strengthened, suggesting this possibility.

The ECRI Leading Index hints that the worst of the US economic slowdown is behind us (see chart below).  The Index has risen in each of the latest 5 weeks (from the February 8 week to March 15 week), albeit modestly.  This is its longest stretch of gains since October 2017.  It will be of interest if it does not turn down in next week's report, which covers the week when stocks declined and the yield curve inverted.  If it does decline, the question will be whether it more than unwinds the recent move up.  If not, the uptrend may still be in place.

The Atlanta Fed model boosted its projection of Q119 Real GDP Growth to 1.2% from 0.4% on Friday, thanks to the large gains in Existing Home Sales and Wholesale Inventories reported last week.  It is too soon to consider this a reliable forecast, however.  And, some of the GDP component estimates could be too low.  But, if the model stays near its current estimate, a speedup to about 3.0% GDP Growth in Q219 would be needed to bring H119 Growth in line with the Fed's 1.9-2.2% Central Tendency for the year. 

ECRI Leading Index (level)