Relief for Stocks from FOMC Meeting and US Economic Data This Week?

The stock market may get some relief from this week's FOMC Meeting and key US economic data, although they are not expected to break new ground.   Steady Fed policy for now, but with rate cuts on the horizon is likely to be the message from this week's FOMC Meeting.  Powell could hint at a September rate cut, but he'll have another opportunity at the Jackson Hole Conference on August 24-26.  Key US economic data are expected to be in line with recent trends showing moderate growth.  As-expected outcomes of the Meeting and data still could help stabilize the market by underscoring the essentially positive macro background. 

The Fed is likely to keep open the door for rate cuts at this week's FOMC Meeting, but reiterate that it needs more evidence that inflation is trending down before deciding to ease.  July and August data will be available ahead of the September FOMC Meeting.  Total PCE Deflator would need to print 0.2% m/m on average in the two months to bring down the y/y from 2.7% in June by the time of the Meeting.  A 0.1% print for Core would keep the y/y steady at 2.6%. 

Recently, Powell highlighted an apparent slowdown in economic activity, providing another reason for a rate cut.  He may not back away from this possibility despite the above-trend 2.8% Q224 Real GDP.  Real GDP Growth was about 2.0% over the first half of the year, well short of the 3.2% 2023 pace.  He also may emphasize that the underlying Final Sales growth of 2.0% (in line with the Q124 pace) is near the longer-run trend.  

To be sure, this near-trend pace doesn't scream for easier monetary policy.  Indeed, the Q224 GDP composition highlights the stimulative force from government policy that Powell (probably for political reasons) hardly, if ever, mentions -- the strength of government purchases, both at the Federal and State & Local level and the strength in Business Equipment Spending, also seen in June Durable Goods Orders, likely reflecting in part government-induced spending on alternative energy and re-shoring of manufacturing from abroad.  So, while a September Fed rate cut is widely expected, it may need more supportive evidence -- perhaps both on the inflation and real-side fronts -- to happen.

The 0.2% m/m Core PCE Deflator in June was somewhat disappointing from the Fed's perspective.  Not as low as the June Core CPI, it matched the m/m increase in June 2023 and kept the y/y steady at 2.6%.  However, the unrounded m/m increase is 0.18%, so was within statistical noise of printing 0.1%.   So, the data will not likely change the Fed's expectation of a downtrend in inflation.  

This week's July Employment Report may reinforce the view that economic growth is solid but still leave open the door for a September rate cut.  Consensus looks for a slight slowdown in Total Nonfarm Payrolls, to +185k m/m from +206k in June.  Private Payrolls are seen speeding up to +155k, versus +136k in June.  Despite the speedup, a sub-200k Payroll print may be soft enough to be viewed positively by the Fed and markets.  Consensus looks for benign prints for the other important parts of the Employment Report.  It sees a steady 4.1% Unemployment Rate and a trend-like 0.3% m/m increase in Average Hourly Earnings.

 

More Downward Pressure on Stocks?

The stock market could remain under pressure from this week's US economic data, but not necessarily as the risks favor friendly prints.  The week's two key pieces of US economic data are the June PCE Deflator and the first-print of Q224 Real GDP.  The consensus estimate of the PCE Deflator is not entirely friendly, as it exceeds the low print seen in the June CPI.  But, consensus risks being too high. Real GDP could be problematic -- the low consensus GDP estimate is a positive for the Fed, but the high Atlanta Fed model estimate is not.  

The consensus estimates for the PCE Deflator -- +0.1%  m/m Total and +0.2% Core -- seem too high,  given the low June CPI (-0.1% Total and 0.1% Core).  Re-weighting the CPI components and taking account of some PPI components suggest the PCE Defllator could be 0.1% pt lower than consensus for both Total and Core.  The y/y would fall for the Total PCE Deflator even with the consensus estimate.  The y/y for Core would be steady with the consensus estimate, but decline if the downside risks materialize.

Consensus looks for 2.0% (q/q, saar) Q224 Real GDP Growth, which would be in line with the Fed's estimate of the longer-run trend and be an acceptably modest pace from a monetary policy perspective.  However, the Atlanta Fed model currently estimates 2.7% for Q224 Real GDP, which would be too high for the Fed.  (The estimate is updated one more time on Wednesday.)  Above-trend growth removes a reason to cut interest rates.   The best that could be said about the Atlanta Fed model estimate is that it would put the H124 Real GDP pace at 2.0%, averaging 2.7% with the 1.3% growth in Q124.  The H124 pace would be near the bottom of the 1.9-2.3% Fed's Central Tendency Forecast for 2024 and in line with the longer-run trend estimate.   Nevertheless, an Atlanta Fed-like print would probably be viewed negatively by the stock market for being too high from the Fed's perspective.

Labor market data are more supportive of the consensus GDP estimate than the Atlanta Fed model's.  First, Total Hours Worked rose 1.6% (q/q, saar) in Q224, versus 0.9% in Q124.  Second, the increase in the Unemployment Rate over Q224 suggests below-trend economic growth, even taking account of lags between growth and the Rate. 

Last Wednesday's sell-off can be explained a number of ways, including the above-consensus prints of almost of all of the week's real-side data -- mentioned as the risks in last week's blog.  One explanation that may resurface is the impact of political decisions stemming from November elections.  The Democrats and Republicans have different agendas, but both are potentially problematic for the economy and stock market.

The press blamed the sell-off in tech stocks on a Bloomberg story about the Biden Administration considering tighter restrictions on chip sales to China.  Tighter restrictions clearly would be a negative for the impacted companies.  The effects would be broader if China takes retaliatory measures.  To be sure, tighter chip restrictions now are just a possibility, and the leak of their consideration conceivably may have aimed at squashing them.

The Trump approach to China (and the rest of the world) appears to be the imposition of 100% tariffs.  This could have several effects.  It would be a clear negative if other countries respond by imposing tariffs on US exports -- a rehash of the Smoot-Hawley Tariff Act of 1930, blamed for worsening the Great Depression.  If other countries don't respond, the dollar should appreciate to a point that offsets the tariffs (to the extent they are passed through fully or partially) -- with no ultimate impact on prices or  economic activity.  However, if foreign companies relocate to the US to beat the tariff, their demand for factories and workers could prompt the markets to crowd out other, domestic, activities in the US.  There would be little net positive effect on overall US economic activity.  Instead, it would lower the US standard of living, as producing goods domestically would be more costly than what had been done abroad.

Corporate Earnings and Real-Side Data Next

The stock market may turn cautious going into the Q224 corporate earnings season.  The macro background was not as supportive as in prior quarters, suggesting there could be more mixed reports (see my June 30 blog).  

The market also will be looking for more evidence arguing for a September Fed rate cut.  After highly favorable inflation data last week,  real-side data for June will be featured this week.  The market will  look for weakness, with Fed Chair Powell having highlighted a growing concern about the possibility of a significant economic slowdown.  Consensus estimates support the idea of slower economic growth.  However, stronger prints in some cases can't be ruled out, which could disappoint the market.

The most important report is for June Retail Sales.  The consensus estimate of 0.0% m/m Total and +0.1% Ex Auto would be the third straight month of sluggish sales.  The risk is that the soft prints for April and May were just the typical pause after a strong month, in which case a third such month is less likely although not unprecedented.  Lower-priced gasoline sales need to be taken out to judge the underlying pace of sales.

Another report that risks exceeding the consensus estimate is June Industrial Production.  Consensus expects 0.3% m/m, versus 0.7% in May.  However, there is upside risk, as Total Hours Worked in Manufacturing rose 0.5% m/m in June, after +0.8% in May.  

Consensus looks for an uptick in June Housing Starts to 1.31 Mn Units after dropping to 1.28 Mn in May.  However, this pace still would be soft, as the June level would be lower than the 1.33 March-April average.   Consensus also expects a dip in June Housing Permits to 1.39 Mn Units from 1.40 Mn in May.  Although Permits tend to lead Starts and Starts lead residential construction activity, there is still residual strength in the latter.  Total Hours Worked in Residential Construction rose in May and June, possibly resulting from the strength of earlier Starts.  

The June CPI was very good news for the Fed.  Importantly, Primary and Owners' Equivalent Rent broke below their recent trend, possibly beginning, at last, to catch up to the flattening in rents shown by private surveys.  If this slower pace continues, the Fed's 2% inflation target is eminently achievable.  The report moves the evidence closer to a Fed rate cut in September. 

Soft Inflation Data Should Help Stocks This Week

The stock market should continue to rally this week, after brushing off soft US economic data last week.  The market appears to be treating weakness as temporary, expecting it to end once the Fed cuts rates.  This week's inflation data for June are expected to support expectations of a Fed rate cut.  Nevertheless, as Fed Chair Powell is likely to repeat at his Semi-Annual Monetary Policy Testimony this week, June data are not sufficient to guarantee a September cut; more evidence of a sustained slowdown in inflation will be needed.  Although Powell is not likely to be specific, July and August data could be the trigger as they will be out before the September FOMC Meeting.

Consensus looks for a benign June CPI this week, with Total up 0.1% m/m and Core up 0.2%.  A flat Total CPI can't be ruled out.  With Powell saying that he liked the May CPI Report (0.0% Total, 0.2% Core), a consensus print for June would be a step in the direction of a September rate cut.  Since the July and August CPI Reports will be out before the September FOMC Meeting, this week's prints will not be decisive.  

Consensus also expects a modest June PPI, although higher than May's.  Total is seen up 0.1% m/m after -0.2% in May.  Core is seen up 0.2% after 0.0% in May.  This report is not as important as the CPI.

Friday's June Employment Report was not an "all clear" for a September Fed rate cut,  but it kept the door open.  The "best" news for the Fed was the increase in the Unemployment Rate to 4.1%.  Greater labor market slack should give Fed officials more confidence that a rate cut would not quickly result in an overly tight labor market.  The Report also pointed to slower economic growth.  Most of the job growth was in low-productivity sectors.  Stripping out the 70k jump in government jobs (mostly in state/local governments) and 82k jump in health/social assistance jobs, Payrolls rose only 54k.  The latest Atlanta Fed model estimate of Q224 Real GDP Growth is1.5% (q/q, saar).

The Employment Report, however, suggests that wage inflation is not low enough for the Fed.  Although the return to the 0.3% m/m trend in Average Hourly Earnings was somewhat of a relief after the +0.4% in May, the Fed would probably like to see it a little lower.  Less than half of the 13 major sectors had low increases of 0.2% or less, as was the case in the prior couple of months.  It shows that the deceleration  in wage inflation to a desirable pace has not been broad-based.