HIGHLIGHTS OF THE WEEK
- Markets started the week off on a good note on French presidential election results and fairly constructive earnings and economic data. The S&P 500 flirted with record highs, and the VIX fell to its lowest level in more than two decades.
- Sentiment soured later in the week as soft inflation data overshadowed a relatively robust retail spending report, with sales up 0.4% atop of an upwardly revised March gain. Total CPI inflation decelerated from 2.3% to 2.2% in April with the core measure slowing from 2.0% to 1.9% on the month.
- Expectations for a Fed rate hike as of June pared back slightly, but remained above 75% through this morning. Unless data continues to disappoint, we expect the Fed will raise rates next month, with another hike likely later on in the year.
SOFT INFLATION DATA PARES JUNE HIKE EXPECTATIONS
Markets started the week off on a forward foot with rising confidence in the global economy, helped by last Friday’s strong U.S. jobs report, further enhanced by the French presidential election results. The price investors demand to protect against volatility dropped, with the VIX falling early in the week, and touching its lowest level since 1993. U.S. equities were also supported by relatively strong earnings reports early in the week, with the S&P 500 flirting with the 2,400 point level. Meanwhile a mild rebound in oil prices, following the bullish inventory report, shored up energy stocks since mid-week. The mood soured somewhat by the end of the week as a relatively good retail sales report was overshadowed by weak CPI data.
The election of Emmanuel Macron as President of France, the centrist candidate who ran on a platform of reform, was expected and largely priced in by markets. Still, it was a welcome development for global investors following the protectionist tilt in popular sentiment across many advanced economies over the past year. The result comes alongside some improvement in economic fortunes. This week, the European Union revised higher its Eurozone and U.K. growth outlook, with industrial production and employment growth in France coming in better than expected recently. But, while the new president has some political capital, he faces significant hurdles to enacting the much needed pro-growth reforms, with much riding on the results of the legislative assembly elections to take place in a month.
The U.S. data calendar was relatively light until Friday. The NFIB Index of Small Business Optimism held up well, while labor market strength was further confirmed by a strong job openings in March and a decline in both initial and continuing claims in early-May. Investors also had a number of Fed speeches to digest. Most of the speeches stuck to the script telegraphed by last week’s FOMC policy statement, suggesting the Committee viewed the early-year weakness as transitory, and expected a firming in ‘hard’ economic data during the second quarter. Most Committee members continue to see a fair chance for two more hikes this year, and see the Fed beginning to wind down the balance sheet late this year or in early-2018.
The Fed’s expectations were only partly confirmed by this morning’s data. April’s retail sales were shy of expectations, but nonetheless indicated more consumption momentum into the second quarter given the upward revisions to March spending figures. On the other hand, consumer price data matched expectations for 0.2% m/m as far as the headline print, but came in weaker after excluding food and energy prices with the core measure up a mere 0.1% m/m. After the unexpected decline in March, the softness in April, which saw the headline and core inflation measures slip to 2.2% and 1.9%, respectively, is likely to somewhat quiet those worried about the Fed falling behind the inflation curve.
While the soft CPI numbers may embolden a more dovish tilt within the FOMC, we believe that the strong April producer and import price data, which typically leads consumer prices, should help support the case for a rate hike. Moreover, while the soft CPI data has slightly pared back expectations for a move next month, markets continue to price in odds near 75%. Ultimately, unless the data continues to disappoint, we don’t expect the Fed will pass on the opportunity to raise rates next month.
Michael Dolega, Director & Senior Economist
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