The Fed's New Strategy and This Week's Key US Economic Data

The Fed's newly revised Statement on Longer-Run Goals and Monetary Policy Strategy sets a pro-growth stance for monetary policy.  Its new goal is to achieve 2% inflation over time, allowing for inflation to exceed this target "for some time" if it missed on the low side beforehand.  It means the Fed will not tighten in the face of above-trend growth that pushes up inflation above 2%.  In some ways, this sounds like an acknowledgement that its tightening in 2018 was a mistake -- which, in fact, it was. 

The roots of the issue go further back.  In the past, the Fed tended to tighten quickly once the economy began rebounding strongly from recession.  As a result, economic growth slowed sharply -- a mid-cycle pause --  leading to a reversal of the Fed tightening.   The Fed is concerned now that it wouldn't be able to ease adequately in such case because rates are so close to the zero bound.  Therefore, it won't raise rates in the early stages of recovery.

The Fed also understands the tremendous social benefits of allowing the unemployment rate to fall to exceptionally low levels, as enumerated by Fed Chair Powell in last week's speech.  In the past, fear of inflation persuaded the Fed not to let the Unemployment Rate fall below what was estimated to be its natural rate, for much of the time seen to be about 5.5%.  The one notable exception was in the late 1990s when Greenspan shifted away from tighter policy even though economic growth was strong.  He was among the first to realize the tech revolution boosted productivity and thereby allowed faster growth without inflation.  He also understood the social benefits from doing so.  The Unemployment Rate fell to 3.9% then. 

The Fed's new hands-off approach will be important in coming months because some upward price adjustments following the virus-induced shutdowns are likely.  They should only temporarily boost inflation and, regardless of policy goals, should not be targeted by tighter monetary policy.  The new policy stance ensures this will not happen.

One inflation channel that could become problematic, however, is a weaker dollar -- particularly since the Fed's new policy stance essentially gives a green light to dollar depreciation.  Regardless of the cause -- easy Fed policy, large Federal deficits, widening trade deficit, low national saving rate, unwinding of "flight to safety" demand as efforts to defeat the virus advance -- a sustained decline in the dollar could lead to higher US inflation.  It is too soon to be concerned, but something to keep in mind.  It could cause the Fed's new stance to backfire, if a weak dollar forces the Fed to tighten before the economy reaches full employment.  The problem of a declining dollar could stem from the Fed's forward-looking communication policy.  It eliminates a degree of uncertainty that otherwise would keep markets in check.

From a market perspective, the new approach is a positive for stocks and Treasury Inflation Protection Securities (TIPS) immediately ahead.  But, it is a negative for longer-term Treasuries,  pushing up their yields.  The steepening of the yield curve could eventually be a significant negative for the stock market, particularly if at some point it signals that inflation fears are getting out of hand.

This week's key US economic data should continue to show a strong Q320 recovery.  Consensus looks for an uptick in the August Mfg ISM to 54.5 from 54.2 in July.  Most other mfg surveys improved in August, and some suggest a stronger-than-consensus print.  August Motor Vehicle Sales could move up from July's 14.5 Mn Units, considering that vehicle production appears to be back to normal.  Consensus expects Initial Claims to fall below 1 Mn.  But, consensus sees August Payrolls slowing, although to a still-strong 1.425 Mn m/m increase from 1.763 Mn in July.  Note that the Claims data argue for a speedup in August Payrolls.  So, an upside surprise can't be ruled out.  The Unemployment Rate is expected to a fall to 9.8% from 10.2%. 

Strong Growth Versus Fears of Slowdown

The stock market should continue to see strong US economic data this week and possibly good news on the virus front, pushing against fears of renewed weakness -- the latter epitomized by the Fed staff's forecast presented at the July FOMC Meeting.  Risks to the outlook will probably be repeated by Fed Chair Powell in his speech at the Jackson Hole Conference this week.  In contrast, the Republican Convention could cushion these fears if the speakers emphasize a pro-growth agenda.

The Fed staff laid out several reasons why they lowered their GDP forecast for H220 -- even as they raised their estimate of Q220 GDP in response to data that came in stronger than they had expected:

"Although the staff assumed additional fiscal stimulus measures would be enacted beyond those anticipated in the June forecast, the positive effect on the economic outlook was outweighed somewhat by the staff's assessment of the likely effects of several other factors.  Those factors included the increasing spread of the coronavirus in the US since mid-June; the reactions of many states and localities in slowing or scaling back the reopening of their economies, especially for businesses , such as restaurants and bars, providing services that entail personal interactions; and some high-frequency indicators that pointed to a deceleration in economic activity." 

Until there is hard evidence that these concerns will be realized, the Fed's forecast perhaps should best be viewed as a reason to expect continuing extremely easy monetary policy.  The Fed's Central Tendency forecast at the June FOMC Meeting was for -7.6% to -5.5% for 2020 Real GDP Growth (Q4/Q4).  This forecast is too weak if Q320 Real GDP Growth comes in 25+%, as the Atlanta Fed model now projects.  The Central Tendencies will be revised at the FOMC Meeting on September 15-16.

Many data released so far for July indeed moderated from the extremely strong pace seen in June.  But, their July gains were still strong.   The few pieces of August data are mixed.  For example, the Phil Fed Mfg Index slipped, although the survey's components  rose (the Index is not based on the survey's components).  The Markit Mfg PMI climbed further above 50, as did the Services PMI.  Initial Claims rebounded in the latest week, but did not fully offset the prior week's drop.  Initial Claims need to move more significantly higher to confirm a noticeable renewed softening in overall labor market conditions.  Consensus looks for them to decline in this coming week's report, however.  At this point, the Claims data suggest a speedup in August Payrolls.

Other data this week are expected to post gains.  These include July New Home Sales and Durable Goods Orders as well as August Chicago PM and University of Michigan Consumer Sentiment.  Q220 Real GDP is expected to be revised up slightly.     

 

 

 

A Second Life for Fiscal Stimulus?

The stock market should continue to benefit from expectations of additional fiscal stimulus in the next few weeks.  On Friday, Trump shifted his position, agreeing to provide funds to state & local governments as well as stimulus checks to families.  These actions would likely push the entire fiscal stimulus action, including the $400 additional unemployment benefit, toward the $2 Tn Democratic goal. It is not certain that Democrats and Republicans will resolve their differences, but the possibility remains while Congress is in recess until early September.

Ironically, the additional fiscal stimulus will hit when the economy already is bouncing back sharply.   The Atlanta Fed Model's estimate of Q320 Real GDP Growth moved up to 26.2% (q/q, saar) from 20.5% after the release of July Retail Sales.  Real Consumer Spending is now projected at 27.8% for this quarter.  This estimate is probably still too low.  So, the risk remains that the Q320 model's GDP projection will be raised further as more data come in.  The next model update is August 18.

This week's US economic data calendar is light, with housing data and a couple of manufacturing surveys on tap.  Consensus looks for sizable increases in July Housing Starts and Existing Home Sales, which seem reasonable.  Consensus sees a decline in the August Phil Fed Mfg Index to 20.5 from 24.1 in July but an increase in the Markit Mfg PMI to 51.8 from 50.9.  The risk is for the Phil Fed Mfg Index to rise, after its July decline ran counter to the Mfg ISM.

The weekly Claims data should be the most important release.  It will be of interest whether the renewed, albeit lower, additional payment will induce more people to apply for regular benefits -- and thus lift Initial Claims.  Last week's sub-1 Mn print for Initial Claims made either or both of two points -- /1/ labor market conditions continue to improve as the economy returns to normal and/or /2/ fewer unemployed people bothered to file for the regular insurance program if they could not also receive the $600 additional assistance.  Arguing for the first point is that labor market conditions should improve sharply if the economy is growing well above trend -- which it is.

The strength of the snapback raises some inflation fears.  The longer-term 5-year inflation expectations component of the University of Michigan Consumer Sentiment Survey is up to 2.7% -- above the 2.3-2.5% range seen prior to the virus.  Some of these concerns are probably overdone.  Much of the 0.6% m/m speedup in the July Core CPI appears to be a one-off reversal of the shutdown-related price cuts.  But, the weaker dollar could be having an effect, as well.  Non-Auto Consumer Goods Imports Prices rose an above-trend 0.2% m/m in June and July.   They fell 0.2% over the 12 months ending in July.

 

Focus on Washington and US Economic Data

The stock market may get some lift from Trump's executive orders reinstating a lowered supplemental unemployment benefit and other measures aimed at mitigating the fall-out from the virus.  It also might be helped by reports that he is considering a cut in the capital gains tax at some point.  But, the legality of his orders may very well be challenged.  And, this risk could limit a positive market reaction.  This week, the market also will deal with Biden's expected announcement of a running mate.  It would likely be a negative for stocks if the person chosen is viewed to be anti-business.  In the background, US economic data are expected to post good-sized gains although not as large as in June.   

Biden's choice of running mate is of particular importance, given his age.  Whoever is chosen has to be viewed more intently than usual as a potential President.  A choice whose views are close to moderate would be a market positive, while a more leftist candidate a negative.

The most important US economic data this week should be Unemployment Claims.  If they confirm last week's declines, it would be a market positive by suggesting the drag from renewed shutdowns in some states is indeed temporary.  In contrast, a rebound in Claims would reignite concern that the economy's bounce-back has slowed sharply.

Other data should confirm a strong rebound in Q320 Real GDP.  Consensus looks for a +1.7% m/m increase in July Retail Sales.  Although this is substantially slower than the +7.5% in June, it is still consistent with a sharp q/q increase in Q320 Consumer Spending.  Similarly for Industrial Production, consensus sees +3.3% m/m in July versus +5.4% in June.  July's inflation data -- PPI and CPI -- are seen recovering from virus-impacted price cuts, with the Core PPI up 0.1% m/m Core CPI up 0.2%.

The Atlanta Fed model's latest projection is +20.5% (q/q, saar), having moved up substantially from its initial 11.9% forecast.  Moreover, the risk is for it to climb toward 30% if not higher as more data come in.  For example, the model now puts Consumption at 21.9%, but the June level already is an annualized 26.8% above the Q220 average.  Also, the risk is for a large rebound in Inventory Investment after it fell an extraordinary $235 Bn in Q220 (although there should be some offset from a corresponding bounce in imports).  The Atlanta Fed model currently expects Inventory Investment to fall even more in Q320. 

 

This Week's Evidence on Whether the Economic Recovery is Slowing

This week, the stock market faces some evidence on whether the economic recovery is slowing in the face of the upsurge in coronavirus infections.  Key data are expected to show little impact so far.  Consensus estimates an uptick in the July Mfg ISM and slower but still strong growth in Payrolls.  Near-consensus prints should be handled in stride by the market.  The risk, however, is for a downtick in the Mfg ISM.  But, it should not prompt much selling since it should remain above 50.  The risk is for a counter-consensus speedup in Payrolls.

Consensus looks for an increase in the Mfg ISM to 53.6 in July from 52.6 in June.  But, the Phil Fed Mfg Index and Markit Mfg PMI give conflicting evidence.  Both correctly predicted direction of Mfg ISM in 5 of 6 months this year.  (Phil Fed was correct in 8 of 12 months in 2019, Markit Mfg in 7.)  The Phil Fed Index suggests a small decline.  The Markit Mfg PMI suggests an increase.  But, the Markit Mfg PMI's increase to 51.3 in July from June's 49.8 could have been just catch-up to the 50+ Mfg ISM print in June.  Nevertheless, the level of the Mfg ISM has exceeded that of the Markit Mfg PMI in each of the past 4 months.  A decline in the Mfg ISM to no less than 51.4 would be consistent with both the Phil Fed and the latter Markit Mfg PMI evidence.

Consensus looks for a slowdown in July Payrolls to +2.260 Mn from +4.800 Mn in June.   The Continuing Claims data, however, point to a speedup in July job growth.  To be sure, much of the May-June jobs gains appear to have been from people who did not file for unemployment benefits.  If they pull back significantly, Payrolls could slow in contrast to the implication of Continuing Claims.  A new BLS survey shows a decline in people with jobs in July, even if last year's seasonals for Household Employment are applied.  But, this is a new survey and relatively small, so cannot be relied upon.

The reason why Continuing Claims suggest a strong Payroll print is that a large amount of re-hiring occurred in the early part of this interval between the June and July Payroll Survey Weeks.  Continuing Claims fell sharply during that period.  The resurgence of the virus appears to have resulted in layoffs late in the interval.  This means that the slowdown in job growth could be seen in August Payrolls rather than July's. 

Consensus looks for a decline in the Unemployment Rate to 10.3% in July from 11.1% in June.  But, a decline to under 10% cannot be ruled out.  A single-digit unemployment rate could be important for the Presidential election campaign.

It is probably too soon for the Presidential election to be a dominant influence on the stock market.  But, there could still be surprises that create at least volatility.  President Trump's threat to ban TikTok from the US is an example.  The market risk is that it could lead to retaliation by China.