Caution After Iran Bombing, But Hope For Fed Easing

The stock market may trade cautiously this week, concerned about fall-out from the US bombing of Iranian nuclear facilities.  Most of this week's US economic data are expected to be on the soft side, sustaining stock-supportive expectations of Fed easing in H225.  And, the early signs from the Unemployment Claims data suggest a slower jobs gain in the next Employment Report, due July 3.  However, Fed Chair Powell's Congressional testimony this week could temper expectations of a near-term Fed easing as it should not diverge significantly from his post-FOMC news conference last week.  

Most of this week's US economic data are expected to be soft.  Consensus looks for declines in both New and Existing Home Sales for May.   May Durable Goods Orders are expected to show a small 0.1% m/m increase in the underlying Ex Transportation Orders.  And, the June Conference Board Consumer Confidence Index is seen up only slightly, remaining among the recently low levels.  May Consumer Spending is expected to speed up a bit to 0.3% m/m from 0.2% in April, but there could be downside risk as well as risk of downward revisions to the prior two months.  The May Core PCE Deflator is seen up 0.1% m/m, in line with the low CPI.  The y/y should stay at 2.5%.  For the Core PCE Deflator to end the year at the the Fed's lower-bound 2.9% Central Tendency Forecast, it has to average a bit more than 0.2% m/m for the rest of the year (including May's).

The latest Unemployment Claims data support other evidence pointing to slower economic growth after the post-winter bounce in April.  Both Initial and Continuing Claims are above their respective May average in the last week or two.  If they stay at these levels, they would point to a smaller increase in Nonfarm Payrolls in June than the +139k m/m in May.  

The Fed's cautious outlook for inflation reflects their fear that tariffs will boost inflation in coming months.  In this week's Congressional testimony, Fed Chair Powell will likely repeat the points he made at his post-FOMC news conference last week.  He said the Fed expects a large amount of the tariff impact will show up in the next few months' inflation data, but it is hard to predict how the tariffs will work through the various parties -- importers, exporters, retailers, consumers, etc.  They may not be fully passed through.  So, the Fed is waiting to see what the net outcome will be.  

Powell should say that economic growth may be slowing.  Real GDP Growth in H125 so far looks to be 1.6% (saar), taking account of the latest Atlanta Fed Model's 3.4% for for Q225 and the actual -0.2% in Q125.  The H1 pace is slightly above the Fed's 1.2-1.5% Central Tendency Forecast for the year -- revised down from the 1.5-1.9% March Forecast because the magnitude of the threatened tariffs now is higher than what it was when the March forecasts were made.  It suggests the Fed sees a H2 slowdown from the H1 pace.  

Although Powell may face criticism from some in Congress (similar to Trump's) about refraining from easing in the face of expected slower economic growth, the Fed's reluctance is consistent with the optimal policy I described in my April 6 blog.  Aiming for slow growth while tariffs are implemented would help prevent a wage-price spiral from developing.  Without wages trying to catch up to tariffs, the latter would just have a one-off impact on prices.  The wage data in the June Employment Report could be important in the Fed's deliberations.