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.
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