Caution Ahead of April PCE Deflator, But...

The stock market will likely trade cautiously into Friday's release of the April PCE Deflator, after the FOMC Minutes reminded that inflation remains too high and sticky from the Fed's perspective.  However, expectations of softer US economic data in the following week, including the May Employment Report, should work against a market sell-off.

Consensus looks for the April Core PCE Deflator to rise 0.3% m/m, which is the risk as discussed in last week's blog.  As mentioned, the jump in the CPI's apparel prices in April, along with continuing high housing rent, are major culprits for a high Core print.  The jump in apparel could be a result of faulty seasonal adjustment, however, in which case it could reverse in May.  So, a knee-jerk market sell-off on a high Core print may not be right.  Moreover, expectations of softer US economic data in the first week of June could mollify inflation fears. The Claims data still suggest a modest increase in May Nonfarm Payrolls.

Market attention could begin  to focus on the Biden Administration's imposition of tariffs on Chinese-made EVs that go into effect on August 1.  Theoretically, imposing tariffs on goods that are already being imported should boost the dollar (weaken foreign currencies), as the tariffs are expected to reduce the amount of imports and thus narrow the trade deficit.  In principle, the dollar should rise enough to cheapen imports so that they and the trade deficit rebound back to levels seen before the imposition of tariffs.  If  tariffs are imposed on only a few imported items, other imported items could benefit.  In other words, US domestic industries that compete with non-tariff imports would be hurt.

However, when the tariffs are meant to prevent the import of goods, like EVs, there's no immediate effect on the trade deficit and therefore on the dollar.  Nevertheless, the possibility of a trade war becomes the threat.  This risk could hurt the Treasury market, concerned that it would lead to higher inflation.  It also could boost the dollar as it precipitates a flight to safety.  This outcome would not be favorable for the stock market.  

This scenario could be problematic for the Fed.  The financial markets' reactions would increase downside risks to economic growth.  However, concern about the potential consequences for inflation from a trade war could hold the Fed back from cutting rates. 

Stock Market Consolidation?

The stock market may consolidate over the next two weeks, as there are few scheduled US economic data releases and caution could prevail before the April PCE Deflator at month end.  Data released so far point to modest economic growth and slowing but still high inflation.  The combination should keep Fed policy on hold, likely to be reiterated in this week's speeches by Fed officials and the FOMC Minutes.  

The two most important US economic data releases over the following couple of weeks should be the April PCE Deflator (due May 31) and May Employment Report (due June 7).  They risk confirming still-high inflation and slow economic growth.  The fear of a still-high PCE Deflator could weigh on the stock market through the rest of May.  A soft Employment Report could re-ignite the market rally.

The Total and Core PCE Deflator may very well print  0.3% m/m for the third consecutive month -- too high from the Fed's perspective and contrary to the tendency of the PCE Deflator to print below the CPI.  Besides rent, the 1.2% m/m jump in apparel prices may be the culprit this month.  It has a fairly high weight in the PCE Deflator, so could tilt the Core up significantly.  The apparel price jump is surprising given the strength of the dollar.  And, import prices show a flattish trend in these prices.   Conceivably, the early timing of Easter could have distorted seasonal adjustment.  If so, apparel prices should fall in May. 

The May Employment Report is likely to show another month of modest job growth.  The Claims data show both Initial and Continuing exceeding their April levels so far in May.  A couple of more weeks' data are needed to confirm this labor market softening.

The latest data show softening in at least two major sectors of the economy -- housing and manufacturing.  Although Housing Starts rebounded, they did not fully recover from March's drop.  Also, the bounce was in multi-families, while the more important 1-family component continued to slip.  And, Building Permits fell for the second month in a row.  Manufacturing Output fell in April, declining for two straight months excluding high tech and motor vehicle production.   High tech output has been an uptrend this year, while motor vehicle assemblies fell back to the Q124 average in April.  From the demand side, consumer spending looks like it should slow in Q224.   The decline in April Ex Auto/Ex Gasoline Retail Sales just partly offset the March jump, so the April level is 1.5% (annualized) above the Q124 average.  Nevertheless, continued sluggish sales in May and June should keep the Q224 pace below the 3.4% Q124 pace.

This Week's Key US Economic Data

The stock market should continue to trend higher this week, as key US economic data are expected to show slower inflation and modest growth.  Although Fed Chair Powell and other Fed officials are slated to speak this week, they are not likely to say anything new.  Most importantly, monetary policy remains on hold.  And, the recent softness in labor market data supports expectations of steady policy for now while leaving open the possibility of rate cuts at some point ahead.

Consensus expects the Total and Core CPI to slow to +0.3% m/m in April from +0.4% in March.  The y/y would slip for both.  However, Total risks printing higher than consensus, boosted by the jump in gasoline prices.  Nevertheless, with gasoline prices stabilizing so far in May, a higher-than-consensus Total will likely be ignored by the markets.  The estimate for Core looks reasonable.  A smaller-than-consensus increase in Core may require a slowdown in Owners' Equivalent Rent to 0.3% from 0.4% and a pause in the sharp upward pace of Motor Vehicle Insurance.  Both would seem to be long shots. 

The other inflation news this week is the April PPI.  Consensus looks for +0.2% m/m for both Total and Core, which would be the same prints as in March.  These would be neutral prints for the markets.

Other key data this week are expected to show a sharp slowdown in Retail Sales in April after they popped in March.  Consensus looks for Total to slow to +0.4% m/m from +0.7% and Ex Auto to slow to +0.2% from +1.1%.  Unless March sales are revised down a lot, consumer spending would still have a solid upward trajectory at the start of Q224.  An issue will be the extent of the consumer's strength.   The Atlanta Fed model's latest estimate of 4.2% Real GDP Growth (q/q, saar) for Q224 has consumer spending up 3.9%.  There is not enough data released so far to attach much reliability to these projections. 

The market may pay attention to the extent to which Housing Starts rebound in April from their March drop.  Consensus sees +6.7% m/m after -14.7% in March.  This would put the level of April Housing Starts at 1.41 Mn units, essentially equal to the Q124 average (1.42 Mn) -- suggesting a flattish underlying trend in residential construction.  The Atlanta Fed model estimates a slight increase in Q224. 

The manufacturing sector was also up modestly in April, according to the consensus estimate of Industrial Production (IP).  Consensus expects +0.2% m/m, after +0.4% in both February and March.   IP (as well as Manufacturing Output) was flat over the 12 months ending in March. 

   

 

Friendly Developments for Stocks

The stock market should continue to be buoyed by the Fed-friendly implications of the April Employment Report this week.  And, in a subtle way, it should continue to be buoyed by Fed Chair Powell's comments, as well.  Powell appears reluctant to harm economic growth to fight inflation, which is a positive for the market's longer-term outlook.

In his post-FOMC news conference, Powell discussed what might bring down inflation without a recession.  He mentioned the lagged methodology by which Owners' Equivalent Rent (OER)  is calculated, saying that OER has not caught up to the flattening seen in private surveys.  His comment suggests that he sees the slow progress toward achieving the Fed's 2% inflation target more as technical rather than a fundamental problem.  Thus, he seems reluctant to aim at economic growth to fight inflation --  a positive for stocks.  Although he did not dismiss the Q124 high inflation prints as resulting from temporary factors, they, in fact, did reflect special factors, such as start-of-year price hikes and lagged pass-through of earlier price increases.  They overstated the underlying trend.  He probably realizes this, but had already rejected the idea of "exing-out" undesirable parts of a figure in past news conferences. 

The April Employment Report is not an all-clear for the Fed, however, so the markets should remain focused on upcoming US economic data for clues on the course of monetary policy.  To be sure, the Report points to continued modest economic growth in Q224.  From one measure, Total Hours Worked (THW) suggest about 2.0% Real GDP Growth for Q224, not that much different from the 1.6% in Q124.  THW stands 1.4% (annualized) above the Q124 average, just a little higher than the 0.9% (q/q, saar) in Q124.   From another measure, the uptick in the Unemployment Rate to 3.9% argues for a sub-2.0% GDP increase in Q224, as the Rate exceeds the 3.8% Q124 average and thus suggests below-trend growth.  The downtick in the Nonfarm Workweek suggests the post-winter bounce-back already has abated.  All these implications suggest the financial markets don't have to work as hard as otherwise to achieve non-inflationary growth.

The slowdown in Average Hourly Earnings to 0.2% m/m is good news for the Fed's anti-inflation fight.  However, it is too soon to give an all-clear for wage inflation, as the slowdown was not widespread.  Only 5 of the 13 sectors had wage increases of 0.2% or less.  The 3-month averages of about half of the sectors were 0.3% or less,