This week, we’re going to flip the typical order of operations in our market commentary and pull the outlook for the week ahead to the top — because it’s going to be a packed week of data. Much of what we learn this week underpins our intermediate-term economic outlook, which we articulated extensively in our recently published quarterly market commentary. In a nutshell, markets are positioned as if the economic cycle is entering a later stage, largely due to uncertainty about inflation and the Fed.
However, we believe markets are underappreciating the amount of slack that remains in the economy while also overestimating inflationary pressures and the Fed. First, inflation is more moderate than headlines suggest, and it’s largely being driven higher by a few outliers and what should be temporary imbalances between supply and demand. We also believe there’s enough slack in the economy (people looking for work, for example) to foster job growth and economic growth and keep prices moderate — a recipe for extremely accommodative monetary policy for the year ahead.
Because it’s such a busy week (we didn’t even mention the opening of earnings season), we might see some volatility as investors adjust projections based on new information. Regardless, stay the course. We think economic growth continues at a heightened pace through the year.
THE WEEK AHEAD
Measures of Productivity: Slack in an economy is, quite simply, the gap between what an economy is using now versus its total capacity. An economy with workers sitting on the sidelines or machines idling in factories, for example, has slack because there’s capacity available to ramp up production. An economy without slack, contrarily, operates at full productive capacity and prices rise as demand outstrips what the economy can produce. This week, we’ll get several reports that help us gauge where the U.S. economy is on that spectrum.
On Thursday, industrial production and capacity utilization data from June are due. The capacity utilization rate measures the percentage of a company’s potential output (capacity) that is being realized. Industrial production, on the other hand, measures output in manufacturing, mining, electric and gas industries. We’ll also parse several reports from the Fed and a few of its district banks, which will provide observations from manufacturers around the country about materials costs, the labor market, inventories, new orders and backlogs — all useful indicators of growth and productivity.
Measures of Prices: Inflation is the market’s focus right now, so expect some reactions to CPI and Core CPI from June when they’re released on Tuesday. CPI rose in May, 0.6 percent compared to April, and set a year-over-year pace of 5 percent. That was the swiftest year-over-year rise in prices since August 2008, but it was largely driven by a 28.5 percent rise in energy costs and a 29.7 percent rise in the cost of used cars and trucks. While prices could bubble higher in June’s CPI subcomponents, we think inflation will eventually roll over as we head toward the end of the year and supply chains catch up with demand.
Measures of Consumers, Business: On Tuesday, the June NFIB small business index, which is the “view from Main Street,” is due. Business owners’ commentary around consumer health and prices (what businesses are paying and whether higher costs are getting passed on to customers) will be noteworthy, but we’ll also want to see if it’s getting easier to hire workers. The week closes Friday with another leading indicator, consumer sentiment, and retail sales from June.
WALL STREET WRAP
ISM Services Declines, Still Near All-Time High: The ISM services index fell back 3.9 percent from May, but the metric remains near all-time highs. The Services PMI registered 60.1 percent in June (a read above 50 indicates expansion), lower than May's all-time high reading of 64 percent. Since 1997 this index has been above 60 only 12 out of 288 months. New orders remain strong at 62.1, and backlog of orders is at a record 65.8. Inventory sentiment also fell to 37.2, which is a strong indicator that respondents feel inventories are too low. That sentiment is setting the economy up for strong replenishment spending in the months ahead.
The ECB, Fed Strike Similar Policy Stances: The European Central Bank completed its policy review and pivoted to an inflation view that’s like the Fed’s policy but with a critical distinction. The ECB will move away from its current inflation goal of “below but close to 2 percent” and is instead opting for a “symmetric” goal around 2 percent, a concession that inflation may, periodically, rise above that mark. It’s a subtle change but one that reflects a more relaxed posture toward rising prices (like the Fed’s).
However, there’s a key difference. While ECB President Christine Lagarde said inflation may transitorily rise above 2 percent, the ECB isn’t pursuing an “average” 2 percent rate of inflation strategy like the Fed. We know 0 percent is the lower bound on rates, which means any adverse shock is going to require especially forceful or persistent action on the part of the ECB to restore symmetry near 2 percent.
Put differently, don’t worry about inflation, as the ECB is here as a backstop. Monetary policy, here and abroad, is set to err on the side of doing too much for too long, and investors need to believe that.
On the Delta Variant: The coronavirus delta variant is, without a doubt, growing into a larger concern. It will certainly have an impact, especially in places where infections are highest. However, the overall economic impact will be nowhere near what we experienced in 2020. It’s a far different ballgame today because we have treatments and more than a year of experience adapting our lives, and the economy, to it. It’s an uncertainty, but we think it’s a fruitless endeavor attempting to trade around the virus or in reaction to headlines that may stir fears about it.
China PMIs Decline: China’s Caixin Services Purchasing Managers' Index (PMI) in June fell to 50.3, which was its lowest level in 14 months. Survey respondents said flare-ups of the coronavirus in South China's Guangdong Province since May have slowed new orders, with export orders rising slightly. The manufacturing PMI, released on July 1, declined to 51.3 in June, its lowest level since April. The Peoples Bank of China (PBOC) responded to a deceleration in growth by cutting its reserve requirement by 0.5 percent.
Growth to Remain Elevated: Growth looks like it will maintain elevated levels in the near term. The latest Atlanta Fed GDPNow tracker has second-quarter growth hitting 7.87 percent, which would be an acceleration from a seasonally adjusted annual rate of 6.4 percent in Q1 and 4.3 percent in Q4 2020.
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