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%.