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.