Stock Market And The FOMC Meeting

The stock market may pull back over the next couple of weeks now that a debt ceiling deal has been announced-- on some profit-taking or caution ahead of the June 13-14 FOMC Meeting.  If so, there is reason to think the market will resume its rally after the Meeting, regardless of the outcome.

There are three possible outcomes to the Meeting -- /1/ a 25 BP hike, /2/ No hike, and /3/ No hike but said to be just a pause in the tightening path. 

 /1/ With recent US economic data pointing to continued growth, and this week's key data risking the same, a 25 BP hike may very well be likely.  But, it could have little impact on the stock market, being viewed as not large enough to significantly damage the economy.  In other words, the economy's momentum could be seen as withstanding modestly higher short-term interest rates. 

 /2/ If the Fed decides not to hike, perhaps to avoid hurting the banking sector or counting on credit tightening to slow the economy, the market should rally.  Such a decision would be pro-growth.  Note that an Atlanta Fed survey suggests credit tightening is having little effect on businesses.  In contrast, Mortgage Applications might be beginning to be impacted by tighter lending standards.

/3/ A pause but with a promise to resume hiking if needed should be a positive for the market, as the immediate danger is pushed ahead.

Claims for Unemployment Insurance undermine the idea of a worsening economy.  Initial Claims have moved down toward the lower end of the range seen since February, suggesting the pace of layoffs has slowed.  And, Continuing Claims have turned down, suggesting hiring has picked up.  The Claims data highlight the risk of another speedup in May Payrolls -- contrary to the consensus estimate of a slowdown.

The consensus estimates of this week's key US economic data encourage the idea of a pause in Fed tightening.  The May Employment Report is expected to show Payrolls slowing to +195k from +253k in April, the Unemployment Rate edging up to 3.5% from 3.4%, and Average Hourly Earnings slowing to +0.3% m/m from +0.5%.  These are all still too strong for the Fed, but their m/m moves are in the right direction.  Consensus also looks for a dip in the June Mfg ISM to 47.0 from 47.1.  Some evidence -- Markit US PMI and lagged Phil Fed Mfg Index -- supports the idea of a decline.  

A decline in Job Openings in the April JOLTS Data would lend support for a pause, as the Fed views the figure as a measure of excess demand for labor.  A decline is far from certain, however.  The question is whether the jump in April Payrolls filled the openings, pushing the latter down.  Or, did the Payroll jump signify a ratcheting up in demand for labor, which could show up in an increase in Job Openings, as well.   

Recent data point to some divergences among the Q223 GDP components, but on balance add up to moderate growth according to the Atlanta Fed model (1.9% is the latest estimate) -- perhaps enough to handle modestly more Fed tightening.  Consumption looks to be moving up, Residential Construction may be flattening out if not turning up, and government purchases (particularly for defense) are strong.  In contrast, net exports and inventory investment have turned down.  This week's report on April Construction Spending will provide more evidence regarding Residential Construction and also business-related construction activity.  The repatriation of manufacturing operations already is showing up in increased construction activity in this sector.  Construction of alternative energy infrastructure and EV-related factories also could provide a boost.

 

 

Policy Pause Coming?

With the debt ceiling crisis possibly close to resolution, the stock market may turn cautious as it focuses on the likelihood of a pause in Fed tightening at the June 13-14 FOMC Meeting.  Fed officials made somewhat conflicting comments regarding a pause last week.  Some Fed Bank Presidents said that recent US economic data were not weak enough to justify a pause.  In contrast, Fed Chair Powell said that rates may not have to be lifted as much as the markets anticipated because of tighter credit conditions stemming from the banking crisis. The decision at the June FOMC Meeting may depend on /1/ upcoming evidence of weak economic activity or low underlying inflation, or /2/ evidence of a sharp tightening in bank lending.

The Fed Presidents are right that the latest data have not been weak.  The most important data last week were the declines in Initial and Continuing Unemployment Benefits Claims.  They reversed the prior week's jumps and brought them back to levels in line with those seen since March.  They do not show a significant worsening labor market in May.  The 4-week average of Initial is 244k, not much different from the 240k going into the April Payroll Survey Week.  Continuing are below the level in the April Survey Week.  We need one more week of Continuing Claims data to complete the picture of the labor market moving into the May Employment Survey Week.  As they stand now, the data raise the risk of another speedup in May Payrolls.

Although a worsening labor market hurts many people, it may be necessary to bring down wage inflation.  What's putting upward pressure on wage inflation may be a too-high level of economic activity.  The level has to fall.  There are two ways to lower the level of activity relative to long-run trend: /1/ recession or /2/ an extended period of below-trend economic growth.  The latter takes time (perhaps more than the typical year-long length of recession).  And, the downside is that high inflation could become entrenched during this period.  Moreover, slow growth would be as painful as recession for some people.  So, the Fed may decide that further aggressive policy tightening with a consequential recession is preferable to a pause in tightening.

One development that could change this decision is a sharp slowdown in price inflation.   The flattening in commodity prices is helpful, but they represent a small share of production costs.  A sharp slowdown in housing rent could help significantly.  Ironically, Fed tightening could be working against   this possibility.  Higher interest rates reduce demand for home ownership, pushing more people into the rental market.  They also make it costlier for builders to construct new homes, thus limiting supply.  Housing Starts have been in the 1.4-1.5 Mn range (annualized), which is below the estimated 1.62 Mn pace needed to meet annual demand.

  

 

 

 

 

Three Areas of Concern for Stocks

The stock market has three areas of concern over the next few weeks:  /1/ action on the debt ceiling,  /2/ extent of economic weakness, and /3/ whether the Fed will pause at the June FOMC Meeting.  These concerns could keep the market in a range.

The debt ceiling has to be raised by the start of June, either for a short or long period of time.  Although the Democrats and Republicans have not budged from their stated positions, the postponement of Friday's meeting of the two leaderships could be a good sign according to news sources.  The two staffs are working behind the scenes to hammer out a solution, and the delay suggests they're still at it.  Presumably, we will know whether they were successful at some point this week.

There are four US economic releases this week that bear on the question of slowdown or recession -- April Retail Sales, April Manufacturing Output (part of Industrial Production), April Housing Starts/Permits and Unemployment Benefit Claims.  Consensus estimates for the first three are more consistent with sluggish growth than recession.  

Consensus looks for Retail Sales to rebound in April after falling in March.  Total is seen +0.7% m/m after -0.6%, while Ex Auto is seen +0.4% after -0.4%.  Revisions to February and March will play a role in determining how April stands relative to Q123.  As currently printed, consensus estimates would put the April level essentially flat relative to the Q123 average.   Note that while the market did not like the drop in the University of Michigan Consumer Sentiment Index for mid May, released on Friday, the Index is not a reliable predictor of Retail Sales.

Consensus expects April Manufacturing Output to edge up 0.1% m/m, after falling 0.5% in March.  The risk is that it could print slightly higher.  Just like for Retail Sales, the consensus estimate would put the level of April Manufacturing Output about equal to the Q123 average.

Consensus sees a small decline in April Housing Starts and flat Permits.  Both levels would be essentially equal to the Q123 average.  What will be important is whether 1-Family Starts/Permits continue to climb, having done so in February and March.  They have a larger and more immediate impact on construction activity than do Multi-Family Units.  

This week's most important release is Unemployment Claims.  They are the broadest measure of economic activity among high-frequency data.  And, it will be important to see if last week's reported jump in Initial Claims carries over to a jump in Continuing Claims in this week's data.  A jump in Continuing will suggest that hiring did not offset the surge in layoffs.  And, if this situation worsens even more over the next couple of weeks, the Claims data would point to a slowdown in May Payrolls and a higher Unemployment Rate.  The Fed may need to see evidence of a weakening labor market to decide whether to pause in tightening.

The latest inflation data were not soft enough to guarantee a pause in Fed tightening, but they didn't close the door either.  /1/ The 0.4% m/m April CPI (Total and Core) is double what the Fed wants.  To be sure, the picture would look a lot better without Owners' Equivalent Rent (OER) and Used Car Prices.  Excluding them, Core CPI rose only 0.2%.  The jump in Used Car Prices could be temporary, as their wholesale prices have begun to decline again.  OER would seem to have room to catch up further to the weakness seen in private surveys of housing rent.  If OER does not slow to 0.2%, then other components of the CPI would have to weaken further to get to the Fed's target.  /2/ The increase in 5-Year Inflation Expectations to 3.2% in the Mid-May Michigan Sentiment Survey is not what the Fed wants to see.  The print is above the 2.8-3.0% recent range, raising the possibility that long-run inflation expectations are becoming unhinged.  The Fed's hawkish rhetoric is not likely to change, even if it pauses in tightening.

 

 

A Good CPI This Week?

The stock market survived last week's unfriendly events -- only a tentative hint of a pause in tightening by the Fed, stronger-than-expected April Employment Report, and renewed fears of bank problems -- as it was helped in part by stronger-than-expected corporate earnings releases.  Corporate earnings could be important this week, as well.  And,  help from a lower-than-consensus April CPI this week can't be ruled out.

Consensus looks for a still-high 0.4% m/m for both Total and Core April CPI.  A consensus print is more than possible.  But, a below-consensus print can't be ruled out.  To be sure, Total should rise by more than March's +0.1% as a result of higher gasoline prices.  But, food and utility gas prices should be soft again.  A below-consensus Core will likely require another low print for Owners' Equivalent Rent, a slowdown in Airfares and Hotel Prices, and flattish Used Car Prices.  A soft April CPI would encourage the market to expect a pause in Fed tightening at the June FOMC Meeting.

The April Employment Report, however, was too strong from the Fed's perspective.  Even taking account of the large downward revision to March, the 2-month average exceeds the pace needed to keep jobs in line with population growth (209k versus 100k).  The low 3.4% Unemployment Rate confirms a very tight labor market.  And, the 0.5% m/m increase in Average Hourly Earnings warns of the inflationary consequences of the latter.

If the +253k m/m April Payroll jump were just catch-up after the +165k March increase, then Payrolls should slow sharply in May.  But, so far, the Claims data don't support this possibility.  In particular, if Continuing Claims stay at their latest level, they would be below the level in the April Payroll Survey Week -- pointing to another speedup in job growth.  This relationship correctly predicted the speedup in April.  There are still several more weeks of Claims data to see before a complete picture is available.  Note that the May Employment Report will be released before the June FOMC Meeting.  So, while a below-consensus April CPI should encourage the idea of a pause in Fed tightening, the question of whether this will happen in June will remain.