Rock, Fed, Hard Place: Ounce of prevention worth a pound of cure
Bottom Line The Federal Reserve’s next policy-setting meeting on July 30-31 will be critically important. The financial markets have priced in with absolute certainty that the Fed will cut interest rates, the only questions being whether it will be 25 or 50 basis points and whether it will be the first of several cuts over the next year. President Trump has also inappropriately pressured Chair Powell to cut rates.
Yet, as the Fed studies the economy, the labor market is strong, consumer spending is robust, inflation is firming and admittedly weak manufacturing trends may be bottoming. Aside from the pending debt-ceiling crisis in the U.S. in September, however, the Fed is monitoring several overseas concerns, including the ongoing Chinese trade and Iranian nuclear discussions, as well as Halloween deadlines for Brexit, the Japanese value-added-tax increase and the end of Mario Draghi’s successful 8-year term as head of the European Central Bank.
So what’s the Fed to do? If it’s data dependent and wishes to demonstrate independence from Trump and the financial markets, then the Fed probably refrains from cutting rates. But at his recent Humphrey-Hawkins testimony before Congress, Powell expressed legitimate concern about uncertain global developments, telegraphing the Fed’s justification for a modest pre-emptive “insurance cut” later this month, with perhaps another to follow later this year.
Macroeconomic data solid
- The labor market enjoyed a powerful rebound in June, posting a much-stronger-than-expected gain of 224,000 nonfarm payroll jobs, reversing May’s aberrantly soft gain of only 72,000 jobs. So monthly payrolls have averaged 172,000 thus far in 2019, with June well above trend. The labor market hasn’t been this strong in half a century.
- Strong retail sales from March through June have completely reversed the aberrantly weak winter results posted in December and February, as the consumer has successfully recovered from the fourth-quarter’s negative wealth effect, the federal government shutdown and the brutal winter weather, which contributed to the weakest Christmas spending in more than a decade and February’s terrible labor market. The personal savings rate remains at a healthy 6.1%, which should help to support solid Back-to-School (BTS) spending this summer.
- Although inflation remains below target and relatively benign, disinflationary pressures appear to have troughed in March and price pressures have begun to gradually increase (with oil and agricultural commodity prices rising), putting core PCE at 1.6% in May and core CPI at 2.1% in June.
- Manufacturing, the proverbial fly in the ointment for the U.S. economy over the past nine months in response to trade uncertainty with China, is exhibiting signs of bottoming. Core capital goods shipments turned positive in April and May, manufacturing payrolls in June soared by a surprising 17,000 jobs, and July’s Empire and Philly Fed regional indexes were much stronger than expected.
The S&P 500 has enjoyed a powerful 28% rally since its Christmas Eve trough to its July 15 record high. While we continue to anticipate some modest market indigestion over the late summer and early fall months, we continue to believe that corrections should be bought, as we reiterate our year-end target of 3,100 for the S&P.
Tweaking our GDP forecasts
The fixed-income and equity investment professionals who comprise Federated’s macroeconomic policy committee met Wednesday to discuss the Fed’s important upcoming decision:
- First-quarter GDP was revised down a tick to a final gain of 3.1%, compared with the fourth quarter’s 2.2% increase.
- The Commerce Department will flash second-quarter 2019 GDP on Friday, July 26, along with its annual benchmark revisions, which typically go back at least three years. We are very encouraged by the better-than-expected consumer spending trends during the period, so we are keeping our estimate unchanged at 2.3%, while the Blue Chip consensus is cutting its estimate from 2% to 1.8% (within a range of 1.2% to 2.3%). The Bloomberg consensus is at 1.7%, and the Atlanta Fed’s GDPNow estimate is at 1.6%, up from 1.4% last week.
- We still expect solid BTS retail sales, but the timing of a possible China trade deal remains highly uncertain. We are ticking up our third quarter 2019 GDP growth estimate from 2.3% to 2.4% while the Blue Chip consensus is reducing its estimate from 2.2% to 1.9% (within a range of 1.3% to 2.5%).
- We are still expecting a much better Christmas this year compared with 2018, but we clearly don’t know if the stronger pace of Chinese exports that we were expecting from an eventual trade deal will actually start to happen this quarter. So we are holding our fourth quarter 2019 GDP growth estimate at 2.6%, while the Blue Chip consensus is ticking its estimate down from 2% to 1.9% (within a range of 1.2% to 2.5%).
- That leaves our full-year 2019 GDP growth estimate unchanged at 2.7%, while the Blue Chip consensus is ticking its estimate down from 2.6% to 2.5% (within a range of 2.3% to 2.7%).
- We do expect the Chinese trade deal to come together by year-end, so we are keeping our full-year 2020 GDP growth estimate unchanged at 2.4%, while the Blue Chip consensus is ticking its estimate down from 1.9% to 1.8% (within a range of 1.2% to 2.3%).