This Week's Key US Economic Data Are in the Details

Most of this week's macroeconomic evidence should continue the positive backdrop to the stock market.  The advance report on Q121 Real GDP Growth is expected to be strong, the FOMC should maintain its easy policy stance, and corporate earnings are likely to continue beating expectations.   But, the markets are beginning to focus on the durability of the very strong growth and the potential for higher inflation.  To this point, the details of this week's data may be more important than the headlines.    

High Q121 Real GDP Growth, like the 6.5% (q/q, saar) consensus or 8.3% Atlanta Fed model estimate, will capture the headlines and probably elicit a knee-jerk bounce in stocks.  The important question for the markets, nonetheless, is what evidence the report provides regarding Q221 economic growth.  The internals of the report should confirm solid momentum in Final Sales, with consumption fueled by stimulus payments and the improving jobs market.  The Personal Income Report, released the following day, will show how far March  consumption stands above the Q121 average -- the take-off point for Q221.  But the markets may discount this evidence, believing the boost from the fiscal stimulus is temporary.  So, what may be more important is what the GDP report's internals show regarding the extent to which Nonfarm Inventory Investment has made up the $300 Bn (annualized) net drawdowns over 2020.  Unless it fully makes up for the decline, re-stocking will remain a catalyst for above-trend growth ahead. 

Last week's report showing a decline in Initial Unemployment Claims to 547k argues that economic growth remained strong going into Q221.  The 577k average of the first two weeks of April is well below the near-790k average of both Q420 and Q121.  Further declines would argue that economic growth has not peaked or at least remains above trend.

Although the Fed has downplayed any high inflation print for now, blaming them on temporary bottlenecks and base effects (see my April 11 blog), the markets are not as sanguine.  So, this week's data on the Q121 Employment Cost Index and March Core PCE Deflator are important.  The internals could be important here, as well.

Consensus looks for +0.7% (q/q) in the Q121 ECI.  This report is typically not a market mover, although it is now bears attention as the least affected by compositional shifts among the major measures of labor costs.  Consensus is slightly higher than the 0.6% 2020 average but the same as the 2019 average, not much to be of concern.  But, there is upside risk, given news reports of some large companies offering higher wages in response to labor shortages combined with the possibility of start-of-year hikes.  In addition, sales commissions could be boosted by the surge in retail sales.  These incentives reflect higher productivity and, as a result, are not inflationary.   The ECI excluding sales commissions could be more important than the headline regarding the inflation outlook.  This measure rose 2.5% (Q4/Q4) in 2020 and 2.7% in 2019.

In contrast, there is downside risk to the consensus estimate of a +0.3% m/m in the March Core PCE Deflator, based on the its different composition from the Core CPI (which printed +0.3% m/m).

 

Did Stocks Get Too Bullish on Economic Growth?

The latest decline in longer-term Treasury yields in the face of very strong US economic data suggests the markets have begun to question the sustainability of the economy's recent strength.  Stocks risk pulling back as a result, since they reacted noticeably to last week's strong prints.  A pullback should be modest and temporary, however,  as the stock market's rally should remain supported by above-consensus corporate earnings releases in the next few weeks. 

The extraordinarily strong March US economic data probably overstate the underlying strength of the recovery.  Temporary boosts from weather rebounds and the injection of stimulus funds likely accounted for some of the large gains.  Nevertheless, growth should remain above trend in coming months.

The boost from better weather was clearly seen in March Housing Starts/Permits data.  All the increase in Permits was in the South and Midwest, which had suffered badly from weather in February.  The Midwest and South saw most of the increase in Starts.  Northeast did also.  All three posted declines in February.  Starts in the West fell in March, after they had risen in the prior month.  The February-March average is 1.60 Mn Units.  It is somewhat less than the 1.656 Mn December-January average, so there may be some flattening in trend -- which is close to the level estimated to be the long-run level of demand for housing.

The Mid-April University of Michigan Consumer Sentiment Index also raised questions about the sustainability of the recent surge in economic activity.  The Expectations Component, at 79.7, is well below the 97.2 Current Conditions Component, suggesting people view the recent strength to be somewhat temporary.  

The Unemployment Claims and manufacturing survey data, like the Current Conditions Component, suggest growth is still well above trend in April.  But, the latest w/w drop in Initial Claims, -193k to 576k (a new low for the move down) could have been impacted by the Easter holiday.  So, the low level needs to be confirmed in this week's report.  If they are, it would be solid evidence that growth remains above trend this month.

The Philadelphia Fed and  NY Empire State Mfg Surveys both point to a very high Mfg ISM in April.  Even so, the chip shortage is restraining some manufacturing activity.  For example, while motor vehicle assemblies rose to 9.3 Mn units in March from 8.9 Mn in February, they remained below the 10.7 Mn in January.  But, all this means is that motor vehicle production will strengthen as chips become more available.

Base Effects, Corporate Earnings and Inflation

Over the next few weeks, the stock market should turn its attention increasingly to Q121 corporate earnings.  Macroeconomic evidence supports expectations of strong earnings, such as the consensus estimate of +20% (y/y).   "Base effects," which translate prior year's weakness into current year strength on a y/y basis, also play a role.

Base effects will impact the y/y calculations for inflation in the next few months, as well.  This is because the sequential, or m/m, change in measures like the CPI and PCE Deflator weakened during the pandemic-induced lockdowns.  So, a return to trend-like inflation now results in a pickup in the y/y inflation rate.  Fed Chair Powell has mentioned this effect a number of times, so they should not affect Fed policy.

The question is whether the base-effect boost to the y/y inflation rate will prove to be temporary.  This will depend on the sequential pace of inflation in coming months.  For both the Core CPI and Core PCE Deflator, the y/y will fall back to well below the Fed's 2.0% target by July if the sequential m/m remains weak at +0.1% m/m.  The y/y remains close to the Fed's target through September if the m/m stays at 0.2% and remains above target if the m/m is 0.3%.                     

                                           Core CPI                                Core PCE Deflator
                                        0.1    0.2    0.3                            0.1    0.2    0.3                           
Jan  (a)                            1.4    1.4    1.4                            1.5    1.5    1.5
Feb  (a)                            1.3    1.3    1.3                           1.4    1.4    1.4
Mar                                 1.4    1.5    1.6                            1.6    1.7    1.8
Apr                                 1.9    2.1    2.3                            2.2    2.4    2.6
May                                2.1    2.3    2.7                            2.0    2.4    2.7
Jun                                  1.9    2.0    2.7                            1.8    2.2    2.6   
Jul                                   1.5    1.8    2.5                            1.6    2.1    2.6
Aug                                 1.2    1.8    2.4                            1.4    2.0    2.6
Sep                                  1.1    1.8    2.6                            1.3    2.0    2.7

This week's US economic data includes the March CPI.  Consensus is for +0.2% m/m Core, and in line with some upside risks including higher apparel prices after an early Easter, pass-through of higher oil prices and supply-side bottlenecks.  Other data should be strong, including March Retail Sales and Industrial Production.  Much of their strength would be a weather-related bounce-back from February drops, so to some extent should not be extrapolated ahead.  However, stimulus checks will be credited for a jump in Retail Sales, as well, and their effect could last for several months.  The most interesting of next week's data will be Initial Claims to see if they remain near their elevated levels of the prior two weeks.  If they do, the apparent absence of significant further improvement in the labor market could raise doubts about the magnitude of the economic recovery.

 

The March Emploiyment Report and Q121 Corporate Earnings Outlook

The markets will be digesting and reacting to Friday's blow-out March Employment Report early this week, with the stock market pitting strong growth against higher long-term yields.  Some of the March strength was one-off, reflecting re-openings and a weather bounce.  But, there was still underlying strength.  The solid recovery supports the consensus expectation of a large y/y increase in Q120 corporate earnings.  These expectations and then the releases, themselves, should help sustain the stock market rally.

Arguably, about half of the +916k jump in Payrolls can be explained as one-off -- seen in Construction, Leisure and Hospitality, and State & Local Government Education jobs.  Taking away about 450k from the headline print still leaves an extraordinary increase, nonetheless.  The rebound in the Nonfarm Workweek to a high 34.9 Hours also signals a speedup in business activity.  This week's reports on March Non-Mfg Purchasing Managers Surveys should reaffirm this improvement.  

The inflation-related components of the March Employment Report were benign.   /1/ Average Hourly Earnings fell 0.1% m/m, with half the major sectors down.  Compositional shifts toward lower-paid workers could have contributed to the decline, however.  /2/ While the Unemployment Rate fell 0.2% pt to 6.0% it remains above the old 5.5% estimate of the inflation threshold and well above the current estimate of 4.0-4.5%.  /3/ A 0.1% pt increase in the Labor Force Participation Rate prevented the Unemployment Rate from falling by more.  If the LFP Rate were steady, the UR would have rounded up to 5.9%.  An increase in the LFP Rate provides the economy more room to grow in a non-inflationary way.  

Consensus expects +20% (y/y) in the S&P 500 earnings for Q121.  Most of the macroeconomic evidence suggests a large gain.  Real GDP could have turned positive on a y/y basis in Q121.  And, the rebound in oil prices should lift profits in this industry.   Similarly, the further weakening the dollar increased the dollar value of earnings abroad.  Although the relationship between the Core CPI and Average Hourly Earnings suggests a squeeze on profit margins, this is probably overstated -- the relatively high pace of AHE on a y/y basis reflects compositional shifts away from low-paid workers rather than a significant speedup in labor costs.  The Employment Cost Index (for private sector) shows no speedup over the past 3 years, essentially steady at 2.6% (Q4/Q4).

                                                                                                                                          Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.6                 +1.7                             3.2           2.3               46.2

Q120           -5.0                -16.5                 +2.9                             3.1           2.3               47.2

Q220         -10.6                -53.5                 +5.9                             6.5           1.4               40.1

Q320           -2.8                -27.8                 +1.0                             4.8           1.7               52.4

Q420           -2.4                -25.5                  -1.9                             4.8           1.6               54.6

 

Q121            0.3                 36.7                  -3.0                              4.9           1.3               58.4                                           

         

* Based on the Atlanta Fed Model's latest projection of +6.0% (q/q, saar).