The Fed's Policy Shift and Q219 Corporate Earnings

Last week's FOMC Statement and "dot" chart affirmed market expectations of easier monetary policy in H219.  While the markets focused on the "dots" chart, the more flexible Statement may eventually be more important.  Nevertheless, the shift could offset the expected anemic y/y for Q219  corporate earnings.

The Statement' said the Fed will "closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion."  It provides for more policy flexibility than the dots' forecast of 50 BPs in cuts over the rest of the year.  Since there are potentially temporary as well as longer-lasting reasons for the economic slowdown (see my blog of June 9), the economic evidence risks improving as the temporary drags disappear.  And, the market reactions could be quick.  So, the Statement's flexibility may turn out to be meaningful than the dots chart, which could change with market expectations.

At this point, evidence is building that the worst of the economic slowdown is behind us.  Initial Claims moved back below the May average in last week's report.  Motor Vehicle Assemblies bounced in May, suggesting the inventory correction in that sector is over.  And, the increase in May Existing Home Sales suggests the drop in mortgage rates is finally beginning to spur housing demand.

But, it does not look at this point that economic growth is back to an acceptable pace -- which I assume to be 3.0%, an above-trend pace consistent with a desired speedup in inflation.  The Atlanta Fed Model's forecast for Q219 Real GDP is now 2.0%.  So, a 25 BP rate cut at the July FOMC Meeting looks reasonable.  This expectation will likely sustain the stock market rally  even though Q219 corporate earnings are expected to be anemic from a y/y perspective.  (And, assuming US/China trade negotiations don't worsen further.)

Corporate Earnings for Q219 could be slightly weaker than for Q119, according to macroeconomic evidence.  Even if the -2.5% y/y consensus estimate is too low, as is typical, the final count may very well be below the +1.6% posted for Q119.
The macroeconomic evidence for Q219 is not much different from that for Q119.  However, US and non-US Real GDP Growth have slowed and profit margins may have shrunk somewhat -- price inflation slowed while wage inflation did not.  Currency translations of earnings from abroad should hurt multi-nationals a bit less, though, as the dollar did not appreciate as much y/y as in Q119.

                                                                                                                                          Markit
                                                                                                                                          Eurozone              Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q117            1.9                +65.3                  2.3                              2.7          2.2                55.6
Q217            2.1                +13.1                  3.1                              2.5          1.8                56.8
Q317            2.3                 +6.0                 -1.9                              2.5           1.7               57.4
Q417            2.5               +12.7                 -4.1                              2.5           1.7               59.7

Q118            2.6               +21.5                 -6.6                              2.7           1.9               59.1
Q218            2.9               +41.0                 -1.8                              2.7           2.2               55.9
Q318            3.0               +45.4                 +5.1                             2.8           2.2               54.3
Q418            3.0                 +6.7                 +6.5                             3.3           2.2               51.7

Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.9                 +6.0                             3.2           2.0               47.8