A Market Breather In The Face of Key US Economic Data and Corporate Earnings?

The stock market may take a breather this week, as it digests recent gains and handles key US economic data.  Consensus estimates of the latter are consistent with the idea of moderate growth and contained wage inflation, but not necessarily soft enough to convince the Fed to cut rates.  Nevertheless, Friday's Personal Income/PCE Deflator Report kept open the possibility of a September rate cut, so any market pullback is likely to be mild and temporary.  Meanwhile, macro evidence raises doubt about the robustness of the consensus estimate of Q224 corporate earnings, soon to be released.

Consensus looks for the June Employment Report to show a slowdown in Payrolls from May's large gain, along with steady 4.0% Unemployment Rate and a reversion to a 0.3% m/m trend in Average Hourly Earnings.  The +180k m/m estimate for Nonfarm Payrolls, versus +272k in May, remains well above the near-100k pace that is consistent with labor force growth.  Nevertheless, it would be in line with other evidence pointing to slower economic growth.  The Q224 average would be 206k m/m, below the 267k average in Q124 and 251k in 2023.  A steady 4.0% Unemployment Rate would keep it above the 3.8% Q124 average.  Unemployment Claims data support the idea of slower Payroll growth in June.  However, their increase last month was only modest, and hiring by Health Care/Social Services and State/Local Governments likely need to soften, as well, to bring the Payroll gain below 200k.

The consensus estimate of an uptick in the Mfg ISM to 49.0 in July from 48.7 in June would likely be favorably viewed by the stock market, as it would argue against the risk of recession.  It still would be low enough to sustain Fed officials' views of a developing economic slowdown.  The Q124 average is  49.1.

The May Personal Income Report was good news for the Fed, showing both slower inflation and consumption growth.  May Real Consumption is 1.7% (annualized) above the Q124 average, pointing to a sub-2.0% Consumption Growth for the second quarter in a row.  The Core PCE Deflator was below the pace in the corresponding month of 2023 in 4 of the 5 months so far this year.  Indeed, the Market-Based Core PCE Deflator has printed 0.1-0.2% m/m in 6 of the past 8 months, with its y/y now down to 2.4%.  The Fed is very close to hitting its 2.0% inflation target according to this measure!

Consensus looks for about 9.0% (y/y) increase in Q224 S&P 500 corporate earnings, better than the 6.0% in Q124.  The macro evidence is not as optimistic.  Although Real GDP Growth is expected to speed up a bit, based on the Atlanta Fed model's current estimate for Q224, other factors are less supportive.  Oil prices slowed, the dollar strengthened (making earnings abroad smaller), and economic activity abroad softened (although stronger than a year ago).  Profit margins look little changed, as both prices and wages slowed similarly.

                                                                                                                                          Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level) 

Q123            1.9                -19.5                +3.0                              4.5           5.5               47.9  

Q223            2.4                -32.0                 +0.5                              4.4           5.2               44.7

Q323            2.9                -12.0                 -2.5                               4.3           4.4               43.2

Q423            3.1                -12.0                 -2.5                               4.3           3.9               43.8

 

Q124            2.9                +14.0                  0.0                              4.3           3.8               46.4

 

Q224            3.0                  +2.5                +3.0                              4.0           3.5               46.2                           

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.2% (q/q, saar).

 

Slowdown Coming (Here)?

The stock market should be helped by a low print of the Fed's targeted inflation figure this week. Nevertheless,  evidence pointing to slower growth is accumulating, with mixed implications for the market.  Although slower growth is a negative for corporate profits, it, along with low inflation, would give the Fed a reason to cut rates.  These two conflicting implications could keep the stock market in a range this summer -- perhaps until it is clear that the Fed will cut rates.  The question remains whether the slowdown is just a temporary unwinding of the post-winter bounce seen in March or whether it is the start of a prolonged period of soft growth.  

Consensus looks for 0.0% m/m Total and +0.1% Core PCE Deflator for May.  A flat Core can't be ruled out.  It would be the fourth month out of the past five when the Core rose by less than it did in the corresponding month of 2023.

The broadest measure of the economy among high-frequency data -- Unemployment Claims -- is blinking "yellow."  Both Initial and Continuing Claims exceeded the May average in the past two weeks.  The higher level does not appear so much above May to signal serious weakness.  And, with strong hiring by the health/social assistance  sector and state/local government, it's not clear that it signals a sharp slowdown in June Payrolls.  However, it raises the possibility that overall economic activity is slowing to below the long-run trend.

The flattish pace of Retail Sales over April and May could be just the typical pause after a strong month (March).  However, along with the downward revision in March Retail Sales, the Q224 increase in Consumer Spending could be lower than the Atlanta Fed model's estimate of +2.5% (q/q, saar) and possibly lower than the 2.0% seen in Q124.  Evidence of such a slowdown in Friday's May Personal Income Report could prompt downward revisions of Q224 Real GDP Growth among Street forecasters as well as the Atlanta Fed model's 3.0% estimate.  

Last week's May Housing Starts Report showed a pullback in this sector.  The decline in Permits suggests a  counter-consensus decline in May New Home Sales, due Wednesday.   Both are derived from the same sample.

Although the June Markit rose for the second month in a row in June, other business surveys remained soft so far.  Manufacturing Output bounced in May after two months of decline.  It remains to be seen whether the May bounce-back will persist or unwind, like a similar bounce did in March.

Away from the data, the broad measures of commodity prices have stalled since March, trading in a flat range.  This remains the case so far in June, suggesting the softening in the US economy is continuing.  At the same time, the flat trend does not suggest recession.

Steady Fed Policy and Moderate Growth: Good Combination for Stocks

The stock market rally is likely to continue at least through the month, as a steady Fed is now in the background and quarter-end buying could develop.  Although Fed Chair Powell provided no new hints regarding the possible timing of a future rate cut, he said the Fed would cut if economic activity weakens sharply.  This comment is a positive for stocks as it reduces a negative "tail" risk.  Meanwhile, steady Fed policy is not a problem while economic growth is moderate.

Powell's comments were asymmetrical with regard to economic growth.  He said the Fed would keep the funds rate steady if growth turns out to be too strong but would lower the rate if growth weakened substantially.  Importantly, he did not say the Fed would raise the funds rate target if growth is too strong. He said the Fed thinks the current policy stance is "about right" relative to incoming economic data.

The evidence regarding the possibility of an economic slowdown is mixed.  Job growth remains strong, but Total Hours Worked have flattened since March and the Unemployment Rate ticked up.  Interestingly, Powell mentioned that there is some thought that recent Payrolls increases are overstated for technical reasons.  He wasn't specific about the reasons, but it suggests the Fed will discount the Payroll data to some extent.

Similarly, although Unemployment Claims jumped in the latest week, the jump could have been exaggerated by issues related to the timing of Memorial Day.  The higher level of Claims has to be matched in coming weeks to signal weaker economic activity. 

This week's US economic data are expected to be consistent with moderate growth.   Consensus looks for +0.3% Total and +0.2% Ex Auto Retail Sales for May.  These estimates are similar to those printed for April, and both could be just the typical slowdown after a jump as was the case in March.  However, it also could be a precursor to slower consumption growth in Q324.  Consensus sees Industrial Production rebounding 0.2% m/m, after a flat April.   Manufacturing Output should rebound, based on the sector's Total Hours Worked.

Powell said the economy is growing about 2%, which he considers a good, appropriate pace at this point.  He thinks the Household Sector is in good shape, although not as strong as a few years ago, presumably implying that consumption should continue to help propel the economy.  Powell seems to be surprised that the tightening in monetary policy has not led to a sharp slowdown in the economy.  He does not talk about the counter-stimulus stemming from Biden-economics -- subsidies to boost alternative energy, repatriation of manufacturing from abroad, increased defense spending, student debt forgiveness, etc.  This stimulus needs to crowd out other spending, given that the economy is operating essentially at full employment.  Perhaps he does not want to suggest that the Administration and Congress are responsible for the higher interest rates and inflation, both of which work to crowd out spending.

A Disappointing FOMC Meeting This Week

The stock market may be disappointed by this week's FOMC Meeting, not finding hints that a rate cut will be forthcoming soon.  Although Friday's May Employment Report wasn't entirely bad news for the Fed, it was bad enough to likely keep Fed policy steady and rhetoric hawkish for now.  In particular, labor cost inflation does not appear to be slowing down.

The Fed's updated Central Tendency Forecasts may not be encouraging, as it should be little changed from the March figures.  To be sure, the Fed's forecast of Real GDP Growth in 2024 could be revised down a bit from 2.0-2.4%, but it is more likely to be little changed if at all.   Real GDP came in substantially lower than expected at 1.3% in Q124, and more recent data have softened.   However, taking the Atlanta Fed model's latest estimate of 3.1% for Q224 Real GDP Growth, the growth rate for H124 is 2.2%.  Sub-2.0% growth for the rest of the year would be required to bring the Q4/Q4 pace below 2.0%.  This cannot be ruled out.  Total Hours Worked have been essentially flat over the past three months.  Although they are above the Q124 average and suggest 2+% GDP growth in Q224, growth could slow in Q324 if Total Hours Worked continue to be flat in the next few months.  However, it is unlikely that Fed officials will lower their GDP forecast significantly at this point.

The Fed's Unemployment Rate and Inflation forecasts will probably be little changed.  The 4.0% May Unemployment Rate is already within the range expected for Q424.  Economic growth has to be projected well below 2.0% in H224 to believe the Rate will move above this range by year end.  The annualized increases in the Total and Core PCE Deflator so far this year are both 4.1%.  Low prints for the rest of the year would be needed to achieve the Fed's annual forecast as of March 2024.  The risk is that the March forecasts turn out to be too low. 

                            Fed's Central Tendency Forecasts for 2024 (as of March 2024)

Real GDP  *                               2.0-2.4%

Unemployment Rate  **             3.9-4.1%        

PCE Deflator  *                          2.3-2.7%            

Core PCE Deflator  *                 2.5-2.8%

* Q4/Q4 percent change

** Level in Q424

This week's May CPI Report is not expected to point to slower inflation.  Consensus expects +0.2% m/m Total and +0.3% Core, the latter equal to this year's trend to date.  A below-consensus print can't be ruled out, but would likely require favorable behavior by a number of components -- including sharp slowdowns in Apparel and Motor Vehicle Insurance as well as a further decline in Airfares -- if Owners' Equivalent Rent does not slow.  There are reasons to think that these components will slow sharply in May.  The price hikes in Apparel in March and April could have resulted from seasonal adjustment issues related to the early timing of Easter.  Motor Vehicle Insurance may be getting close to catching up to the increased cost of motor vehicle repair stemming from electronically complicated vehicles.  Motor vehicle repair prices flattened out in April. 

Much of the high inflation seen so far this year reflects one-off start-of-year price hikes, questionable seasonable adjustment, changes in relative prices, pass-through of legislated hikes in the minimum wage (e.g., fast-food restaurant prices) and changes in the nature of the item being measured (e.g.,  motor vehicle repair and insurance).  However, last week's release of the revised Compensation/Hour -- the broadest measure of labor costs -- shows only a slight slowdown in labor costs -- the most important factor behind inflation.  Compensation/Hour rose 4.2% (q/q, saar) in Q124, slightly slower than the 4.4% (Q4/Q4) pace in 2023.  An absence of significant slowdown also is seen in the 0.4% m/m increase in May Average Hourly Earnings.  Although the large increase could be just an offset to the low 0.2% April print, the 2-month average of 0.3% equals the recent trend.  The Fed would probably like to see a significant slowdown in labor costs to be comfortable that inflation is moving down.

 

Fed/Stock Market Friendly Data This Week?

The stock market may continue to recover from last week's sell-off, as evidence of slow economic growth keeps alive the possibility of Fed rate cuts later this year.  Along with Friday's Personal Income/Consumption Report, the Employment Report and other key data this week are expected to be Fed friendly. 

Consensus expects the May Employment Report to extend the modest tone seen in April.  It sees Nonfarm Payrolls up by 180k m/m versus +175k in April.   Indeed, the Unemployment Claims data lean toward a smaller jobs increase in May than in April.  Consensus also expects the Unemployment Rate to be steady at  3.9% and Average Hourly Earnings to return to their recent trend of 0.3% m/m from the low +0.2% in April.  The y/y for AHE would be steady at 3.9%.  There is no reliable evidence for either, however.

This week's other key data are expected to describe a softening labor market and modest economic growth.  Consensus looks for the JOLTS data to show a decline in Job Openings to 8.35 Mn in April from 8.488 Mn in March.  This is a reasonable estimate since the data are based on the same sample used in constructing the Payroll data, which showed a slowdown in April.  Although consensus sees an uptick in the Mfg ISM to 49.8 in May from 49.2 in April, the estimate remains below 50.

Friday's report on April Personal Income/Consumption/PCE Deflator gives reason to believe GDP growth will remain modest in Q224.  Real Consumption in April was only 1.3% (annualized) above the Q124 average.  Assuming some m/m gains in May and June would result in 2.0-3.0% Real Consumption Growth (q/q, saar) in Q224 -- not much different from the 2.0% in Q124.  The data led the Atlanta Fed model to cut its estimate of Q224 Real GDP to 2.7% from 3.5%.

The inflation side of the report also is favorable from the Fed's perspective.  The 0.2% m/m increase in the Core PCE Deflator extended this year's period when core inflation printed below the corresponding month's increase in 2023.  This supports the view expressed by a number of Fed officials that inflation is on a downtrend.  To be sure, a slowdown in Owners' Equivalent Rent in coming months would be highly desirable for this view to be realized.