Is The Extreme Volatility Over?

The stock and bond market will hopefully settle down this week after their extreme volatility last week.  The end result of last week's actions are lower stocks and higher longer-term yields, although the volatility suggests it took awhile to figure out the right equilibrium levels.   It may take strong demand at a Treasury auction to signal yields are high enough, however.

One explanation heard is that yields rose in anticipation of higher inflation, sparked by the current increase in commodity prices and fears of very strong growth ahead.  And, the higher yields hurt stocks, particularly in the tech sector.  An implication is that any softening in commodity prices or US economic data should boost both markets.  Perhaps the best outcome regarding data would be if they point to moderate growth and inflation.

Another way to understand what happened is through an "optimal control" approach -- with a large fiscal stimulus bill to be passed soon, the stock and Treasury markets don't have to "work" as hard to lift the economy.  A direct implication of this approach is that a final bill that contains less than $1.9 Tn in fiscal stimulus should boost both stock and Treasury markets.  News reports suggest changes to the House bill will be made in the Senate.  The goal is to get both Houses to pass a bill before March 14, so some give and take may happen.

This week's key US economic data may be moderate enough to calm the markets.  Consensus looks for a speedup in February Nonfarm Payrolls to +165k m/m from +49k in January.  The February estimate is essentially equal to the +167k 2019 m/m average, a year when Real GDP Growth was a modestly above-trend 2.3%.  So, a near-consensus print could trim fears of excessive economic growth near term.

While the Atlanta Fed model's forecast was cut to 8.8% from 9.6% last week, it is still probably too high.  Besides it being much too high relative to Total Hours Worked, as discussed in last week's blog, its Consumption forecast of 7.7% is about 1% pt above the pace suggested by January Real Consumer Spending (released on Friday).

Evidence on February Payrolls is mixed.  /1/ The February survey may have picked up re-hiring by re-opened restaurants.  /2/ School re-openings may continue to lift jobs, as they apparently did in January.   /3/ The extremely cold weather in Texas occurred after the Survey Week, so any weather-related layoffs there won't show up.  /4/ The Claims data don't suggest a very large gain.  Initial Claims averaged 837k over the weeks between the January and February Survey Weeks, not much different from the 844k between the December and January Weeks.  Continuing Claims fell by less between January and February than they did between December and January.  

Consensus looks for a steady 6.3% Unemployment Rate.  The risks are balanced.  The Claims data suggest a dip, but there could be a rebound in the Labor Force after it fell sharply in January.

Consensus looks for a near-trend 0.2% m/m increase in Average Hourly Earnings.  There is downside risk if the bulk of the jobs gain is in low-paid restaurant workers.

The other key data is the February Manufacturing ISM Index.  Consensus looks for an uptick to 58.8 from 58.7 in January.  While a number of already-released business surveys show a dip for February, they could be just catching up to the decline seen in the Mfg ISM in January, which they had missed.  A near-consensus print would show the manufacturing sector remains strong, but is not accelerating.  Non-US survey data so far are mixed for February.  European PMIs improved, but the official Chinese PMI slipped.

 

 

 

Stock Market Battle: Growth Versus Inflation and Interest Rates

Two macroeconomic themes began battling themselves in the stock market last week -- the prospect of strong economic growth this year (market positive) versus higher inflation and interest rates (market negative).  Fears of higher inflation and rates dominated the overall market, although one-off post-earnings profit-taking may have added to the negative theme.  Two developments this week could tilt the battle to the positive side -- a return of warm weather in the Midwest and the prospect of a fiscal stimulus bill being finalized by the end of the week.  Fed Chair Powell's testimony is likely to repeat his intent to keep monetary policy easy and his support for large fiscal stimulus.

Fiscal Stimulus 

The House is expected to pass its $1.9 Tn fiscal stimulus bill by the end of this week and the Senate next.  A bill is expected to be ready for signing by March 8.  There apparently is still some disagreement among Senate Democrats about the size and composition of the bill.  So, the final outcome is not certain.  A somewhat smaller total with more focused payments would probably take the sting out of the markets' fears without reducing the economic impact by much. 

There is concern that a $1.9 Tn fiscal stimulus will add to an already fast-recovering economy.  But, some of the stimulus just prevents consumption or state & local government spending from falling.   And, some of the stimulus will be saved or spent on imports.  In these cases,  the stimulus will not boost growth.

Inflation Fears

Inflation fears may be overdone in any case.  Much of the recent higher inflation -- mainly in commodity prices -- has resulted from the strong economic recovery.  Demand has outstripped supply for some inputs, causing shortages according to many business surveys.  For example, Motor Vehicle Prices were up in the January PPI, presumably because the chip shortage forced production delays.  In some cases, if not most, however, supply will eventually catch up, and prices will stabilize.  Other price jumps resulted from temporary developments.  Oil prices jumped because of the weather and a prior Saudi output cut.  Temperatures will be warming in the Midwest this week.  And, the Saudis announced an increase in output beginning April.  So, the run-up in oil prices may pause at this point.

The 0.0% m/m January Core CPI showed that not all prices are speeding up.  Some components suggested the possibility that the weaker dollar and higher oil prices are being passed through.  But, others showed that the impact of the virus continues to hold down price increases. 

 Economic Growth

It is difficult to get a handle on Q121 Real GDP Growth at this time, as there is very few data points.  While Retail Sales were very strong in January, they may unwind to some extent in February and March.  This would be their typical pattern after a strong month.   Also, there could be some offsets in GDP from an inventory reduction and higher imports.  Weather issues may have temporarily held down housing construction in January and possibly February.  But, the manufacturing sector remained strong, despite a decline in motor vehicle production (presumably related to chip shortages).  Manufacturing Output posted a large gain in January.  Manufacturing surveys stayed at high levels in February.

Labor market data do not fully support the Atlanta Fed model's early projection of 9.5% Q121 Real GDP Growth.  Total Hours Worked in January are only 2.5% (annualized) above the Q420 average.  The Claims data show the pace of layoffs remains high.  While re-hiring appears to be happening, based on the further decline in Continuing Claims, the rate of decline in the latter has slowed.   The drop in the Unemployment Rate to 6.3% in January from 6.7% is consistent with very strong GDP Growth, although a decline in the labor force was behind the drop.

This week's US economic data will add to evidence on Q121 Real GDP Growth but not likely affect the "battle" very much.  January Trade Deficit and Wholesale Inventories feed into GDP projections.  January New Home Sales and Durable Goods Orders are expected to be up.  January Core PCE Deflator is seen slowing to +0.1% m/m from +0.3%, with the y/y falling back to 1.4% from 1.5%.  

 

Stock Market Rally In the Face of Chip Shortage

The stock market's rally remains on track, underpinned by expectations of new fiscal stimulus and increased vaccinations.   The latter is already helping the economy, with indoor eating at restaurants beginning in New York and other places.  The latest hiccup, however, is the shortage of chips, which is impeding production in a number of industries, particularly motor vehicles.  

The chip shortage's impact could knock a noticeable amount from Q121 Real GDP Growth if it lasts through March.  It should worsen a number of economic data, including Retail Sales, Unemployment Claims, Payrolls, and Business Investment (in equipment and inventories).  But, it could be viewed as setting up for a bounce-back in economic activity later in the year.  This could mitigate a negative impact on the overall market.

Weak prints will probably be trumpeted as support for the $1.9 Tn Democratic stimulus package.  But, this would be incorrect.  Since the shortage's impact stems from supply constraints, not inadequate demand, fiscal stimulus will not address the problem.  Instead, it could exacerbate the inflationary implications of the shortage.

The re-starting of indoor restaurant eating could help the labor market considerably.  This relatively low-productivity industry requires a lot of workers, so its expansion could make a significant dent in unemployment.  

A contraction in high-paying industries, due to the chip shortage, combined with the expansion of low-paying industries, like restaurants, could hold down aggregate measures of wage inflation.  It also could boost a shift in consumption to services from goods (particularly durables).

It is probably too soon to see the impact of the chip shortage in this week's US economic data, except for Unemployment Claims.  Consensus looks for a decent 1.0% m/m rebound in January Retail Sales (both Total and Ex Auto) after they dropped in December (-0.7% and -1.4%, respectively).   Consensus sees +0.4% m/m Total and +0.2% Core PPI, both near the recent trend.   It sees a slight pullback in January Housing Starts/Permits.  Consensus sees little impact from the chip shortage on Initial Claims and February Markit US Mfg PMI.  It expects Initial to fall to 775k from 790k in the prior week.  And, it sees only a downtick in the Markit US Mfg PMI to 58.5 in February from 59.2 in January.  The risks presumably are for weaker prints.

Fiscal Stimulus Ahead, But...

The stock market will likely continue to be lifted by expectations of a speedup in economic growth stemming from increased vaccinations and new fiscal stimulus.  Biden's comment that a $15 minimum wage looks like it won't be included in a reconciliation stimulus bill is a market positive for the near term.  The Trump impeachment trial, which begins this week, should be background noise.  

While the final stimulus package appears to be still in flux, two parts that should be in the final version are the one-time payment to low-income people and assistance to state & local governments.  Their bang for the buck may disappoint, however.  Increased vaccinations may have the bigger positive impact on economic growth.

While low-income people tend to spend all their income, theory says that one-time payments tend to be saved (or used to pay down debt).  Theory  seemed to hold last year when much of the one-time stimulus payments was saved or used to pay down debt.  Even if the payments are spent, a good share of the spending will be siphoned away from the economy through imports.  Moreover, the recent rise in oil prices is a partial offset to an increase in stimulus payments in terms of consumer purchasing power (although it should help boost domestic oil production). 

As for the state & local government assistance, much of it aims to keep current operations going.  So, the economic impact will be to prevent a drag rather than add to growth.

This week has a light calendar for US economic data.  The most important is the January CPI.  Consensus looks for +0.4% m/m Total and +0.2% Core.  There is always the risk for the January CPI to be boosted by start-of-year price hikes, although seasonal factors should try to offset them.  The weaker dollar also could lift import prices that feed into the CPI.  Consensus seems to be looking for price hikes -- at least more than occurred last year, as it expects the y/y for Core to rise to 1.6% from 1.5%.  In contrast, the pandemic could weigh on pricing of such items as rents.  All told, the risks seem to be balanced.  Note that even with a 0.3% Core trend, it will take several years to unwind the shortfall relative to the Fed's 2% target that has built up over the years.

The other important data will be the weekly Unemployment Claims data, particularly if they confirm last week's strength.  Last week's data moved closer to signaling the end of the impact of the virus-induced shutdowns that began in December.  The 68k w/w drop in Initial Claims to 779k put them at a level last seen in October-November (799k and 740k average, respectively). The week's decline also was notable because it ran counter to the possibility of a post-holiday rebound.