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.