HIGHLIGHTS OF THE WEEK
- Investors were kept busy this week with plenty of top-tier data, both internationally and domestically, alongside a Fed meeting mid-week. International PMIs suggested some slowing in global economies, largely related to trade tensions.
- U.S. PMIs also pulled-back, but other data was far more constructive. Consumer spending accelerated to 0.4% in March, setting the second quarter on a solid growth path, which should come in near 3%.
- Firming inflation was the main story this week, with the PCE deflator (and core measure) accelerating to 2.0% and 1.9%, respectively. The Fed has taken notice of this, indicating in the statement a more confident view of the inflation outlook. This should enable the Fed to raise rates at least twice more times this year, with three hikes likely during 2019.
Fed Increasingly Confident On Inflation Outlook
The start of May has been busy for investors with a mid-week Fed rate decision and plenty of economic data to sift through. Domestic data generally outperformed, sending the U.S. dollar and rates higher, but yields pulled back a touch towards Friday. Higher dollar and rates weighed on U.S. equities, while international stocks saw some upward movement on lower yields and exchange rates – related to somewhat weaker data.
International data this week revealed that economic momentum continued to slow in April. The most recent international PMIs softened somewhat, however much of the softness can likely be attributed to heightened trade uncertainty. Protectionist themes and tariffs have been making headlines on a regular basis, denting business confidence and stifling expansion plans. For instance, this week the Trump administration doubled down on demands for China to reduce its trade surplus with the U.S. by $200 billion.
Most critically, domestic businesses appear unable to escape the rising tide of trade protectionism. Both the manufacturing and non-manufacturing ISM indices pulled back 2 points apiece in April. However, they remain near cycle highs, and are indicative of ongoing healthy pace of growth.
mestic data confirms that growth remains solid despite the downside risks. Personal income rose by a healthy 0.3% in March, while consumer spending rose 0.4%, consistent with the narrative of tax cuts and rising jobs and wages motivating Americans to shop. A rebound in spending in the second quarter supports an outlook that sees economic activity expanding around 3%, a trend that we anticipate to hold through the end of the year.
The persistence of strong, above-trend growth is driving price pressures higher. Inflation strengthened in March, reaching 2% according to the PCE deflator (the Fed’s preferred measure). The core PCE deflator (which strips out the most volatile components) also strengthened to 1.9%, just a hair below the FOMC target of 2%. The Fed took notice of this data during their meeting this week. Although it kept rates on hold, some notable changes to the wording were made. All told, the Fed’s confidence regarding inflation and its outlook should provide it with the conviction to keep moving rates higher, assuming wage and prices rise as expected.
This morning’s payroll report for April was consistent with this view despite the headline miss. Although wage growth slowed a touch, the drop in the unemployment rate to a 17-year low of 3.9% suggests that wage and price pressures should continue to gradually build.
Ultimately, inflation holding near target is consistent with our call for two more rate hikes from the Fed this year, with the next hike likely coming in June. That said, it’s not out-of-the question that the Committee raises rates by another 75 basis points this year. This gradual pace of tightening should help minimize the risk of slowing activity too quickly and resulting in a recession, something the FOMC officials are keenly trying to avoid..
Michael Dolega, Senior Economist | 416-983-0500
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