Does the Fed Have a Problem?

The Fed does not have to change its FOMC Statement by much on Wednesday to accommodate the strong Q119 Real GDP and March Payroll prints with its "patient" approach to monetary policy.  All the Statement needs is to drop "growth of economic activity has slowed from its solid rate in the fourth quarter.   Payroll employment was little changed in February,...." and indicate that growth was strong and job gains were solid on average in Q119.  It can keep its justification for steady policy, saying "In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes."  The financial developments could refer to the flat Treasury yield curve, so still could be referenced despite the stock market rally.

The Fed still has a problem, though, but does not have to face it until June.  It had lowered its 2019 GDP Central Tendency forecast in March to 1.9-2.2%.   Assuming the advance print of 3.2% for Q119 Real GDP Growth holds through revisions, Real GDP Growth would have to slow to 1.9% on average over the next 3 quarters to hit the upper end of this forecast.  There is little reason to think this will be case, despite the attempt by some Street economists to dismiss Q119 GDP strength to temporary factors.  Early evidence points to speedups in Consumer Spending and Business Equipment Spending, so another 3+% quarter cannot be ruled out.  

Even if the Fed raises its Real GDP forecast at the June FOMC Meeting, there is a chance it could lower its inflation forecast.  The y/y for the Core PCE Deflator was 1.8% in January.  It should fall to about 1.6% by March, based on the CPI and the Q119 Core PCE Deflator print -- well below the Fed's 2.0% target.  By lowering its inflation forecast, the Fed could justify maintaining its steady monetary policy. 

This week's April Employment Report will likely underscore the dichotomy between strong growth and low inflation.   The Claims data suggest a 200k+ Payroll gain and a decline in the Unemployment Rate from 3.8%.  But, calendar considerations argue for a modest 0.1-0.2% m/m  Hourly Earnings.  Consensus is +173k Payrolls, 3.8% Unemployment Rate and 0.3% AHE.  Note that the most interesting part of Payrolls in this report will be whether manufacturing and construction jobs speed up.  These two sectors have lagged the overall economy recently.  A speedup in their job growth would bode well for a strong Q219 GDP gain.

Other US economic data this week risk being soft.  The April Mfg ISM should decline, based on most regional manufacturing surveys.   Consensus looks for a dip to 55.0 from 55.3 in March.  The March Core PCE Deflator should be 0.0-0.1% m/m, as opposed to the 0.2% consensus estimate, based on the low CPI.  The Q119 Employment Cost Index risks coming in below the consensus estimate of a steady 0.7% q/q, since Average Hourly Earnings slowed in Q119 from its Q418 pace.