The most recent employment numbers indicate the economy is slowing. The Fed is likely to implement one more interest rate hike anyway.
The Week That Was
Friday’s employment report provided the first hints of slower pace of hiring. March payroll jobs, hours worked, and hourly earnings all increased at slightly slower rates than in prior months. Private jobs increased by 189,000, well below the 300,000 average of the prior two months.
March business surveys were mixed. Both ISM and S&P service sector surveys show continued growth with readings slightly above break-even. However, the readings are down sharply from February.
The ISM survey new orders component for services fell to 52, down from 63 in February. Manufacturing new orders fell to 44, down from 47.
Both business surveys show inflation remains a problem. Although prices are close to stable in manufacturing, inflation in the service sector remains a problem, with a reading close to 60, 10 points above price stability.
Things to Come
Friday’s March retail sales data will be significant. Although February’s sales were down slightly from January, they were up at an 8 percent annualized rate from the fourth quarter. If the economy is shifting downward as we suspect, March sales will be down for the second consecutive month.
Money, Money, Money
Wednesday’s consumer price index figure will provide the main input for the Fed’s policy decision on May 3.
The Fed’s favorite inflation measure (personal consumption deflators) showed an annualized inflation in the 3 percent vicinity in February. Business surveys suggest the March inflation rate could be higher.
In contrast to the Fed’s favorite measure, February’s CPI numbers showed annualized inflation rates of 5 percent to 6 percent. We expect March to be lower.
Even so, inflation will remain above 5 percent on a year-over-year basis, even if it is only 0.2 percent in March.
Although there is currently a 60 percent probability the Fed will pause, it will be difficult for the governors to do so without losing credibility. We continue to expect another 25-basis hike in May.
Market Forces
Stock prices and longer-term interest rates ended the week where they ended a week ago.
We are in a tricky period for stocks, where interest rates are falling. When interest rates fall, it raises the fundamental value of stocks. However, the interest rate decline appears to be in anticipation of a projected significant weakness in the economy.
Until there is a clearer picture of the extent of the coming downturn, and how quickly inflation will subside, the S&P500 will remain in the range of 3,900 to 4,200, the same range of the past six months.
March was the ninth month of monetary restraint. Fed data for the first week in April show banks continued to increase their deposits with the Fed, taking money out of the economy. This makes monetary policy more restrictive, not less.
As a result, the odds of greater weakness in the months ahead are increasing. Upcoming CPI data could force the Fed to maintain restraint far longer than necessary.
At this point, monetary data suggest the financial markets are correct in assuming a downturn in the economy is coming. However, the downturn will help to relieve inflationary pressures by the latter half of the year.
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Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 16 percent
Monetary Policy: restrictive
