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Look back at May 20, 2019 week: A thin data calendar left the focus on the FOMC and markets’ expectations for a rate cut

A look back at the May 20 week suggests that a number of things will remain unsettled and uncertain, and as a result the outlook for the US economy will adopt that tone.

First and foremost are the unresolved issues around trade and tariff policy with China. For the present, higher tariffs are going to cost domestic business more to obtain products from abroad, and potentially could disrupt supply chains, particularly for electronics with the ban on exports of technology. Businesses are adapting and putting contingency plans into effect. Adding on to the import/export picture is widespread and repeated flooding in parts of the Midwest that have disrupted traffic of goods and hurt the agricultural sector which can’t get the product it has to market and faces an abbreviated and risking growing season. Potentially these will all have the impact of heating upward price pressures.

The minutes of the April 30-May 1 FOMC meeting were carefully parsed to see if the Committee had in fact turned more dovish on the outlook for interest rates in the face of some low readings of the PCE deflator. Instead, there was little sign that the consensus is worried about price stability in spite of the recent downward trend in its favored inflation measure. Other inflation indicators – including the Dallas Fed’s Trimmed Mean PCE Inflation Rate which was mentioned in the minutes – suggest that the FOMC is correct in viewing the Bureau of Economic Analysis measure as understating inflation due to some idiosyncratic factors that will move through the data.  The Dallas Trimmed Mean was up 2.0% in March compared to the 1.5% for the PCE deflator and up 1.6% for the core CPE deflator. This backs up what the CPI has shown as the underlying trend for inflation.

Concerns about the Fed’s credibility on maintaining its 2% inflation objective are nothing new.  In part calls for a rate cut by the FOMC are fueled by demands that policymakers prove that credibility by lowering short-term rates. However, the Fed has a dual mandate and a focus on the medium term. The vigor in the labor market provides plenty of reason not to cut – and was one of the main reasons for rate hikes last year. A few months of below-objective inflation readings does not offset the sustained undershoot on the longer-run forecast for the unemployment rate of 4.3%. At the same time, inflation expectations measures have regained a tenth or two and are not materially different then they have been for the past few years.

Thus, the consensus of policymakers is for a pause in rate hikes to allow an assessment of the risks from geopolitical developments and time to see if transitory factors are passing through the PCE deflator data.  If markets were anxious for the Fed to agree with their more downbeat outlook, they didn’t get it.

The sparse economic data calendar had a few disappointments for the housing market without derailing hopes that coming months will be active ones.  Sales of existing homes were down 0.4% to 5.19 million units (SAAR) in April, and off 4.4% from a year-ago. Sales of new single-family homes were down 6.9% in April to 673,000 units (SAAR), but up 7.0% compared to April 2018. In both cases, the month total was probably in line with the market fundamentals. Early 2019 is coming off a sluggish performance in the second half of 2018. Declines in mortgage interest rates have helped inspire consumers to re-enter the housing market at a time when sales are normally slower. As a result, the month-to-month level changes can be noisy. However, the April numbers point to two things: supplies of homes have improved even if still limited, and the price a homebuyer is willing to pay is higher due to better affordability with a lower mortgage rate. Continued low mortgage rates will keep new buyers in the market and perhaps lead to some refinancing activity.

At 211,000, new claims for jobless benefits in the week ended May 18 were little changed from the prior week at 212,000. There may be some short-term volatility in the numbers from things like the timing of holidays and another chain store closing up, but on the whole the labor market is tight. The 1.2% insured rate of unemployment hasn’t budged in over a year. Employment may be a lagging indicator of the health of the economy, but it would have to deteriorate significantly to be described as anything but healthy.

Conditions in May for the manufacturing and service sectors as expressed in surveys from the Fed’s District Banks has generally been at least modest in tone. The Kansas City Fed’s Manufacturing Index for May was essentially unchanged at 4 from 5 in April and March. Taken in the context of the firmer readings from the New York general business conditions index (17.8 in May from 10.1 in April) and Philadelphia (16.6 in May from 8.5 in April), activity in the factory sector is continued to expand. The Philadelphia Fed’s nonmanufacturing index for May dipped to 17.3 after 21.0 in April and suggested that the underlying pace is still rising moderately.

New orders for durable goods in April declined 2.1% after up 1.7% in March. This series commonly alternates between softer and firmer readings and the dip in April was well-anticipated due to the weakness in aircraft orders. Excluding transportation, new orders were flat.

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