Focus Back on the Fed

This week's market focus will be primarily on the July FOMC Minutes (due Wednesday) and Fed Chair Powell's speech at the Jackson Hole Conference (Friday).  Neither should diverge from Powell's message at the post-FOMC meeting news conference -- economy is strong, Fed sees some downside risks, it has moved in response to these risks, and stands ready to do so again if needed.  Now that the markets are less concerned about a near-term recession, a reiteration of this message should be a positive for the stock market, in contrast to the sell-off following Powell's comments at the press conference.

Last week, the markets had some solace over the US economic outlook from the strong July Retail Sales report.  July Housing Starts also showed underlying strength, even though Total Starts fell.  (The apparent responsiveness of 1-Family Permits and Starts to lower mortgage rates argues against those analysts who say easing monetary policy won't work to boost the economy under current circumstances.)  The Atlanta Fed model's Q219 forecast moved up to 2.2% from 1.9% after these reports.  The forecast now exceeds the Fed's 1.8-2.0% estimate of the long-run potential growth rate.

Ironically, the markets ignored some softer data.   Unemployment Claims bounced toward their recent highs in the latest week, after they had been signaling economic strength through the recession-fear moves in the stock and Treasury markets,   In addition, Manufacturing Output Excluding Motor Vehicles unwound their June bounce, showing that this sector remains under pressure from global economic weakness.  The bright spot in manufacturing is now Motor Vehicles, which appear to be past their Spring inventory correction.  Assemblies rose further in July,  the 3rd consecutive monthly increase.

In total, last week's real-side data underscored the Fed's perception of the US economy.  Growth remains acceptable, but downside risks from weak global growth are showing up in some areas.  This narrow area of softness in economic activity for now justifies the Fed's cautious approach to easing.

Another justification is the risk that inflation finally may be beginning to move up.  The Core CPI rose 0.3% m/m in the past 2 months.  Labor Compensation/Hour (the broadest measure of labor costs) surged over H119, according to revised data.  The 4.3% y/y in Q219 is a post-recession high and well above the near-3% range seen in other labor cost measures.  This is high even taking account of strong productivity gains.  Unit Labor Costs are up to 2.5% (y/y) in Q219, well above the 1.0% in Q418.  The Phillips Curve may not be dead after all.

To be sure, global real-side data are expected to remain soft, as well.  Consensus looks for dips in the Markit European "Flash" Purchasing Managers Indexes (PMIs), due Thursday.  However, soft European PMIs could have a neutral to positive impact on stocks and the euro if they bolster expectations for German fiscal stimulus, as was suggested in a report on Friday.  The prospect that European fiscal policy will finally act to counter economic weakness there also takes pressure off the Fed to ease in response to downside global risks.   It is a negative for Treasuries.