Macro Problems Dissipate For Now

The stock market may continue to climb this week in the absence of significant US economic data and an apparent pause in implementing tariffs.  The Fed is firmly in the background for several reasons.  Instead, the implications of the evolving macroeconomic path for monetary policy will be best seen in the ups and downs of long-term Treasury yields.  At this point, economic growth and inflation look satisfactory, once special factors are taken into account.

Fed monetary policy is on hold.  Powell and other Fed officials have made this clear, saying both policy and the economy are in a good place.  Besides these fundamental reasons for steady policy, Trump's call for lower rates stymies rate decisions in both directions.  Unless there is convincing evidence that a policy change is needed, cutting rates would raise concern that the Fed is buckling under political pressure.  Raising rates would bring on even more political pressure.  The Fed is likely to be very careful in its deliberations over the next rate move. 

Both inflation and real-side economic data for January may have been impacted by special factors, which allowed the market to discount their significance.  Although the January CPI rose more than expected, large increases in just a handful of components were responsible.  They were likely one-off start-of-year price hikes.  Bad weather across the country probably caused January Retail Sales to fall.  The part of Retail Sales that feeds into the calculation of Consumer Spending in GDP was flat relative to the Q424 average.  Sales should rebound over February and March, however, as the weather improves.  This week's January Housing Starts could be depressed temporarily by the weather, as well.  

The sustained low levels of Initial and Continuing Claims into February attest to the underlying solid performance of the economy despite the bad weather.  The strength of commodity prices also suggests US and global economic growth are doing fine.

There remains a question regarding the underlying pace of the economy and inflation once these temporary factors iron out.  The Trump Administration's cutting or disrupting government spending, both at the federal and state levels,  could exert some drag on the economy.  In addition, the plunge in illegal immigration could restrain both government spending and consumption.   As for inflation, the pass-through of the tariffs on China and steel and aluminum to consumer prices remains to be seen.  And, wage rates remain an issue, despite Powell's assertion that it is not a source of inflationary pressures.  The continuing sharp increase in food prices could spark demands for higher wages.

The tariff issue is now "in committee" as Trump directed officials to determine how to implement "reciprocal tariffs."  News reports suggest they will be difficult to implement, as many imports are made across a number of countries.  Perhaps in the end, the threat of reciprocal tariffs could be just a bargaining tool to force other countries to cut their tariffs on US exports, as has happened to some extent already with India.  In this case, reciprocal tariffs would not be a problem for the stock market.  The market, however, may turn cautious as the March 1 decision regarding Canadian/Mexican tariffs approaches.