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Not ‘Cutting’ It: Full Week Ahead Preview

Powell back on the hot seat.

If you’re amused by the juxtaposition between optically solid economic data and increasingly dovish monetary policy, the week ahead should be a blast.

No sooner had the advance read on Q1 GDP blown past estimates on Friday, than Larry Kudlow showed up on CNBC to insist that just because the economy grew at a 3.2% annualized pace in the first quarter (well above even the post optimistic estimate from 72 economists surveyed) doesn’t mean we don’t still need rate cuts. No, the internals from the GDP report weren’t particularly inspiring, but the point is, the idea of rate cuts when unemployment is sitting at a five-decade nadir and the economy is growing at a 3% clip is absurd.

With that as the backdrop, we’ll get the Fed this week along with ECI, PCE, consumer confidence, ISM Manufacturing and, of course, April payrolls.

Obviously, the Fed is under all kinds of political pressure to cut rates and as much as I’d like to tell you that it would be a complete and total shocker if they did, I regret to say that we have reached a point in the United States where nothing would surprise me in terms of how the steady erosion of previously independent institutions ends up manifesting itself. The Fed is leaning heavily on subdued inflation to justify the “patient” narrative (it’s likely that at some point in the future, they’ll alter their reaction function around inflation and move to a new framework) and the Trump administration jumps at every opportunity to suggest that low inflation opens the door to rate cuts.

“The reaction function of the Fed appears to have changed, placing more weight on a symmetric fulfillment of the inflation mandate, and we expect continued signaling of a greater willingness to let inflation overshoot the 2% target to reinforce inflationary expectations”, Barclays wrote Sunday, adding that “the Fed could also discuss the terminal composition of its balance sheet and provide more detail into the conclusion for balance sheet runoff.”

While an actual cut is highly unlikely, Powell will doubtlessly be asked about the threshold. The Wall Street Journal made sure this issue is front and center by running another silly trial balloon last week (see our satirical take here).

“Market participants will listen for clues about longer-run issues in Chairman Powell’s press conference [including] a possible ‘recalibration’ rate cut, [which] has received growing attention following recent comments from Fed officials”, Goldman wrote Thursday, on the way to reminding you that Evans recently said that if core inflation “fell sustainably to 1.5% and if he thought inflation expectations were more consistent with 1.5% inflation, he would think about ‘taking out insurance’ by cutting rates.”

(Goldman)

Goldman continues, writing that, if asked, Powell “will probably be less specific than Evans, [but] he might agree that in principle a sufficiently low level of inflation and inflation expectations could justify a cut.”

Just to drive the point home, most analyst previews suggest that the language around current economic conditions in the statement will be upgraded, which means the tension between the robust economy and the apparently live discussion of rate cuts will be thrown into even starker relief. It’s becoming increasingly clear that the dual mandate is morphing into a single mandate and indeed, there are rumors that the Fed may decide to intentionally run the labor market super-hot and justify that by pointing to subdued inflation.

“We suspect that Chair Powell will strike a sanguine tone on the economy citing stronger data on growth but a more cautious note on inflation as trend inflation has slowed and inflation expectations remain weak”, BofA says, adding that “he will likely reinforce the Fed’s symmetric inflation objective and argue that the latest inflation data allows the Fed to be patient in the hiking cycle.”

Here’s a snapshot from Goldman that shows you how the data has evolved since the March meeting:

(Goldman)

Essentially, the Fed is expected to pull off a moderately dovish hold, and that has the potential to be set against a series of economic indicators that could well make a dovish lean seem even more bizarre.

Payrolls easily topped estimates in March, “proving” the February debacle was a hiccup. Here’s what an economy that needs rate cuts looks like, apparently:

As a reminder, we’re still riding a record streak of monthly gains, now at 101.

JobsStreak

Goldman sees the headline number printing 195k for April, with the unemployment rate unchanged at 3.8%. They’re looking for AHE to increase 0.2% MoM and +3.2% YoY on unfavorable calendar effects. Barclays is even more optimistic. “We forecast nonfarm payrolls to have increased 200k in April, the unemployment rate to decline to 3.7%, average hourly earnings to have increased 0.3% MoM (3.3% YoY).

It’s always possible that we get a “rogue” AHE number (i.e., something much hotter than expected) that throws a monkey wrench into this charade where rate cuts can somehow be reconciled with an overheating labor market as long as inflation stays well-behaved, but don’t hold your breath.

Meanwhile, ISM will be watched closely as well. Some have pointed to the following chart as evidence that things are out of whack, but be cautious of simplistic interpretations of two series plotted on separate axes with no nuance.

If you’re looking for a more compelling ISM chart, try this one:

(SocGen) 

That’s a nice segue, as markets will get PMI data out of China this week.

You’ll recall that the March PMI beats were the catalyst for a sudden U-turn in the market narrative. The post-March-FOMC “growth scare” story morphed into a “nascent cyclical reflation” tale that persisted for the entirety of April, thanks in no small part to the fact that, on the heels of the upbeat PMIs out of Beijing, China turned in a beat on exports, better-than-expected credit growth data, blockbuster March activity numbers, a Q1 GDP print that beat estimates and, on Saturday, an ostensibly good read on industrial firms’ profits.

Markets will be looking for a continuation of the inflection shown below when this week’s PMIs cross.

ChinaPMIMr

This comes as the US and China resume trade talks which are said to be in the final stages.

“We expect bids to reemerge in CNH on potential headlines from the ongoing US-China trade talks and our expectation for China manufacturing PMI to stay in expansionary territory, although with some moderation from March”, Barclays wrote over the weekend.

The worry, though, is that the better the data is out of China, the less inclined Beijing will be to deploy stimulus. Indeed, the “good news is bad news” dynamic was the proximate cause for last week’s selloff in Mainland shares, which fell the most since October.

In Europe, we’ll get GDP. As you’re probably aware, the bloc is struggling to shake off recession worries in the wake of a sharp downgrade to the outlook from the ECB in March and amid ongoing signs of weakness out of Germany, where a deep manufacturing slump threatens to plunge the world’s fourth-largest economy into a downturn. Inflation data is on deck across the pond as well. Here’s where things stand on growth (the red highlight shows Germany barely dodging a technical recession in Q4):

GermEurGDP

Meanwhile, the political outlook in Italy continues to deteriorate and EU elections loom.

The dollar will continue to be watched close in light of the relative strength of the US economy, which has, so far anyway, easily outweighed whatever greenback weakness “should” have accompanied a dovish Fed.

With the dollar sitting at a YTD high, concerns about a dollar liquidity shortage have resurfaced, and idiosyncratic risks in Argentina and Turkey are flaring up again, raising the specter of a 2018 re-run for EM. This is a particularly vexing situation – on one hand, a Fed that’s predisposed to cutting rates should be bullish, but on the other hand, the dollar is buoyant. EM FX is coming off its worst week of the year.

Full calendar via BofAML

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