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.