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The market is at a stage where it does not know exactly what it wants. Just look at the up and down action of last week, lurching back and forth in big point moves. Actually, it knows what it wants, i.e. a Fed that quits raising rates, solid economic data, and lower energy prices. That is not going to happen, however, so it is trying to figure out what is the best combination of less than perfect indicators it can live with, if any.
The Fed is on the warpath against inflation, something made clear by Fed statements since the recent FOMC minutes where some concluded the Fed was considering slowing the pace. The Fed has come out since and made clear it does not see that as the case, at least not yet. The market knows that the Fed often produces economic slowdowns at the minimum when it takes on inflation or what it perceives to be inflation. Thus it needs something that will cause the Fed to curtail the length of its current campaign. That would be weaker economic data and slowing signs of inflation.
The data last week, however, did not show this to be quite the case. The NY Empire PMI was very weak, housing starts were way down, and the Leading Economic Indicators fell once more. All continuing signs of a slowdown that has shown up in data that started showing up the past three months even before the mainstream caught on. On the other hand the Philly Fed was very strong, the core CPI was much stronger, jobless claims tumbled, and corporate earnings and outlooks were good. That will likely be more than enough to keep a Fed on its proclaimed path. Once the Fed embarks upon a campaign, tightening or loosening, it takes major changes to alter its course. This data is certainly not enough to do that.
The market, however, appeared to cheer the good Philly Fed regional manufacturing report on Thursday after reacting negatively to the data that would suggest less economic growth (and thus a less active Fed) earlier in the week. Yet it sold Wednesday in reaction to the hotter than expected CPI, something you would expect from a market that fears the Fed. Mixed signals: worried about an economic slowdown yet also fearing a Fed that fears there is too much growth and the start of inflation. Thus good economic news is both good and bad, and bad economic news is both bad and good.
Oil prices not enough to slow fed either. It has said that it would take $80/bbl to $100/bbl to really adversely impact the economy. That alone says it all. Oil at $55? No problem according to the Fed. It is a problem, however, as the retail stores are already commenting on changing consumer habits here in April, long before gasoline hits $3/gallon later this summer when demand really climbs. Higher oil is doing part of the Fed’s perceived job for it, i.e. quelling demand some as consumers divert discretionary dollars into their gas tanks. History shows us that oil at current prices for such an extended period do cause economic slowdowns. We see it starting to happen with the consumer data coming in (sales, sentiment reports). The Fed, however, is choosing to ignore certain aspects of the real world in order to apply its stated policy just as it did in 1999 and 2000. The Fed wants higher rates. It feels it has to get rates to a point where the next Fed chairman has ammunition to act as he or she feels necessary. Greenspan is also determined not to let inflation take hold as he leaves office. He probably would like to be in the position to let the next chairman lower rates to start as opposed to raising them.
Thus we have a market grappling with energy prices, specifically gasoline, that are only going to get worse in the coming months and divert more consumption dollars. Add that to already slowing economic data and a Fed still saying it is going to raise rates indefinitely, and you have real concern about the Fed tightening into a slowdown as it did in late 1999 and 2000. The data are still strong, but they were also strong back then. Data is often strong until it breaks down, particularly when the Fed is raising rates. Those rate hikes all hit at once. Combined with any natural slowing say due to high energy prices and you can have a real problem.
The Fed is on the warpath against inflation, something made clear by Fed statements since the recent FOMC minutes where some concluded the Fed was considering slowing the pace. The Fed has come out since and made clear it does not see that as the case, at least not yet. The market knows that the Fed often produces economic slowdowns at the minimum when it takes on inflation or what it perceives to be inflation. Thus it needs something that will cause the Fed to curtail the length of its current campaign. That would be weaker economic data and slowing signs of inflation.
The data last week, however, did not show this to be quite the case. The NY Empire PMI was very weak, housing starts were way down, and the Leading Economic Indicators fell once more. All continuing signs of a slowdown that has shown up in data that started showing up the past three months even before the mainstream caught on. On the other hand the Philly Fed was very strong, the core CPI was much stronger, jobless claims tumbled, and corporate earnings and outlooks were good. That will likely be more than enough to keep a Fed on its proclaimed path. Once the Fed embarks upon a campaign, tightening or loosening, it takes major changes to alter its course. This data is certainly not enough to do that.
The market, however, appeared to cheer the good Philly Fed regional manufacturing report on Thursday after reacting negatively to the data that would suggest less economic growth (and thus a less active Fed) earlier in the week. Yet it sold Wednesday in reaction to the hotter than expected CPI, something you would expect from a market that fears the Fed. Mixed signals: worried about an economic slowdown yet also fearing a Fed that fears there is too much growth and the start of inflation. Thus good economic news is both good and bad, and bad economic news is both bad and good.
Oil prices not enough to slow fed either. It has said that it would take $80/bbl to $100/bbl to really adversely impact the economy. That alone says it all. Oil at $55? No problem according to the Fed. It is a problem, however, as the retail stores are already commenting on changing consumer habits here in April, long before gasoline hits $3/gallon later this summer when demand really climbs. Higher oil is doing part of the Fed’s perceived job for it, i.e. quelling demand some as consumers divert discretionary dollars into their gas tanks. History shows us that oil at current prices for such an extended period do cause economic slowdowns. We see it starting to happen with the consumer data coming in (sales, sentiment reports). The Fed, however, is choosing to ignore certain aspects of the real world in order to apply its stated policy just as it did in 1999 and 2000. The Fed wants higher rates. It feels it has to get rates to a point where the next Fed chairman has ammunition to act as he or she feels necessary. Greenspan is also determined not to let inflation take hold as he leaves office. He probably would like to be in the position to let the next chairman lower rates to start as opposed to raising them.
Thus we have a market grappling with energy prices, specifically gasoline, that are only going to get worse in the coming months and divert more consumption dollars. Add that to already slowing economic data and a Fed still saying it is going to raise rates indefinitely, and you have real concern about the Fed tightening into a slowdown as it did in late 1999 and 2000. The data are still strong, but they were also strong back then. Data is often strong until it breaks down, particularly when the Fed is raising rates. Those rate hikes all hit at once. Combined with any natural slowing say due to high energy prices and you can have a real problem.