First quarter growth is likely to fall flat - at least that is the signal from numerous forecasters and the Atlanta Fed. But what does it mean for Fed policy? Probably not much for now. It will leave policymakers a little cautious as we head toward the June FOMC meeting (May seems most likely a off the table for policy action). But mostly the Fed will be watching incoming data from the end of the first quarter and the beginning of the second. If the data flow picks up over the next couple of months, they will likely move forward with a June hike. They seem to be in a "what, me worry?" frame of mind.
Retail sales stumbled in March, following up on a revised decline in February as well. Motor vehicle sales are partly to blame; we have likely seen the peak in car sales for this cycle and are settling into a lower pace of activity going forward. Lower gas prices and sluggish sales at building supply stores contributed to the fall as well. Stripping out the more volatile components, however, suggests a bit more stability in sales than suggested by the headline numbers:
March inflation came in lower than expected, with a surprise hit to core:
Ocular econometrics suggests the March print is something of an outlier - the first monthly decrease since 2010. A big 7 percent decline in cellular service prices played a roll, as did falling used car and apparel prices. While I anticipate a rebound in April, this kind of print will help keep the Fed's inflation forecast intact thus preventing them from stepping up the pace of tightening. Watch how this plays through to core-PCE inflation. As a reminder, that was running hot in the first two months of the year:
In another sign that the Fed's inflation metrics will remain contained, the PPI for health services remained subdued in March:
The New York Federal Reserve issued its survey of inflation expectations for February. Interesting split between the high and low numeracy groups:
The low numeracy group tends to be more volatile, so I anticipate it will revert back in the next month.
How will any of this matter for the Fed? First, remember that the Fed started dismissing first quarter data at the March FOMC meeting. From the minutes:
Participants generally saw the incoming economic information as consistent, overall, with their expectations and indicated that their views about the economic outlook had changed little since the January-February FOMC meeting. Although GDP appeared to be expanding relatively slowly in the current quarter, that development seemed primarily to reflect temporary factors, possibly including residual seasonality.
Hence I don't think they will be surprised by a weak GDP number; they will be surprised if that weakness looks to be carrying forward into the second quarter.
Second, I think the same goes for inflation. For the moment, I think that the decline in unemployment to 4.5% will weigh more heavily on their decisions than a weak inflation number. Still, I believe that if inflation looks to be tracking below their forecasts, they will eventually reduce their estimate of the natural rate. Just not right away.
Third, I think this take on Federal Reserve Chair Janet Yellen's talk last week from Marc Chandler is accurate:
We had detected a shift in the Fed’s stance that we characterized as looking for data to confirm the recovery to now looking for opportunities to normalize conditions. Yellen sees similarly. She said the Fed has shifted from “a post-crisis exercise of healing” to now trying to sustain the economic progress.
The Fed is not living in the crisis anymore. Policymakers no longer worry about trying to boost the pace of activity. The economy is, by their estimates, near full employment with growth is near potential growth. In this framework, a normal economy demands a more normal monetary policy. Policymakers are thinking that the expansion will be eight years old this summer with a good chance that this could turn into the longest running US economic expansion on record. They generally believe that preemptive but gradual rate hikes offer the best chance of expanding the expansion to ten years and beyond. Hence I tend to think their bias is to continue along the current policy path, which suggests they will continue to sound hawkish relative to what recent data would suggest.
Bottom Line: Fed likely to dismiss recent data as unrepresentative of underlying economic trends.
