The Fed fixation continues. We have gone through a Fed dance every few months in a cycle we seem doomed to repeat. The dance steps include an economy that apparently is gaining momentum, Fed governors openly worrying about the stronger economy and musing on higher rates, followed by a softer stock market and weaker economic data. Then the Fed backs away from threatened rate increases, markets rise, and the economy acts better.
The economy was neither nearly as weak as appeared this winter, nor as strong as it appears now
Repeat every three to six months. This has been ongoing since late 2014, maybe earlier if you count the worries over when the Fed would stop buying new bonds under one of its quantitative easing programs. At the moment, the U.S. economy has undergone the stronger-economy and whispering-about-a-rate-hike step of the dance. We think that the strong-growth step may not last as long as usual.
We suspect the brick-and-mortar retailer slump and a clear peaking in the auto industry could hit some key economic indicators before the Fed's June meeting. The U.S. economic data for the week was consistently strong with better housing data, industrial production figures, and a larger-than-expected increase in consumer prices.
Combined with this month’s retail sales report, the U.S. economy has apparently made an amazing deathbed recovery from yet another winter sinking spell. The economy's apparent rise from the dead generated fears of a potential Fed rate increase and a sharply accelerating economy.
Do not be fooled by that narrative. Weather and seasonal factors, whose influences are more apparent in a low-growth environment, have produced three terrible first GDP quarters in a row. The economy was neither nearly as weak as appeared this winter, nor as strong as it appears now. In our opinion, the economy will struggle mightily to stay in its 2.0%-2.5% GDP growth channel, as energy prices move higher, the workforce ages, and population growth sinks.
Focus on Stocks Not GDP Predictions
Central banks will be relatively helpless in reversing this demographic reality. We continue to believe that investors' focus on central bank actions remains misplaced. Some of that time would be better spent focusing on the economy's demographic winners and losers.
Alternatively, following up on the shift in retailing away from expensive brand names, imported goods, and online retailing might yield more investor profits. Still, relatively high valuations, a likely continuing profit squeeze due to higher wages, and a limited ability to raise prices will provide a powerful headwind for corporations and world equity markets in the months ahead.
US Poised for Inflation Bounce
Headline inflation shocked some last week as month-to-month inflation jumped to 0.4%, driven largely by higher energy prices. Core inflation, excluding food and energy, was up 0.2%, which still annualizes to over 2% annual inflation. Year-over-year total inflation for April was just 1.1%, still benefiting from lower energy prices. That year-over-year figure has bounced around between 1.1% and 1.3% since the January spike. Core inflation, excluding food and energy, is running at 2.2% year over year, very near the recovery high.
With energy tailwinds continuing for a few more months and modest food inflation, the total CPI number may not get a lot worse until August, which is when gasoline prices started to fall apart a year ago. We still expect headline inflation to be well over 2% by December.
