A Short-Run Forecast For The U.S. Market

by: Robert Craig-Stephenson

Friday saw the most anticipated news about the US economy, namely the Non-Farm Payroll [NFP] and the Unemployment Rate report. NFP came out 180,000 versus forecast of 130,000 (50,000 extra jobs created), while the Unemployment Rate shows a surprise drop to 4.4% versus previous forecast of 4.6%.

The bond market reacted by completely removing the probability of a Fed rate cut by August while retaining a minor probability for Q4 cuts. 10-yr Treasury sold off by 7 basis points - a large move relative to movements in the last two weeks.

The stock market, as proxied by the Index Futures, were trading up 0.3-0.5% initially, buoyed by the temporary view that everyone may "spend like it's 2006 again". It closed unchanged at the end of the day, as shown in my Bloomberg screen. Only 2000 contracts traded on Friday, versus 20-25,000 on normal business days.

Forecasting the economy in the short run is very challenging as it combines a) my ability to forecast economic "data" going forward, and b) my forecast of the likely market reaction to the forecasted data.

Let's go to the "easy" part, which looks to me like the upcoming economic data. Next Friday (the 13th!) will see the release of PPI. This number is expected to decline to 0.7% from 1.3% last month. The Core PPI is expected to also decline from 0.4% to 0.2%. So it is fair to say that the PPI will be between 0.7% and 1.3%. We just want to know right now, which number it will be closer to.

In March, oil prices go up, quite a bit I should say (by more than $4). Gas prices at the pump noticeably went up, too. Friday's tight employment number suggest the labor share is not helping either. Therefore, the most recent data points to a number closer to the upper range of forecast, which is 1.3% and 0.4% for Nominal and Core PPI, respectively.

I will spare you the CPI forecast for the 17th, as I think it will show upward inflation pressure very similar in trend I forecasted to the PPI. It suffices to say the the PPI and CPI are likely on the "uncomfortable" side of Bernanke's equation.

The other possibly important data point is the Michigan U Sentiment Report. I could imagine this number to come out below the already weak forecast, due to the higher gas and food prices.

What else ... Oh yes, the Housing Market. On the 17th the Housing Starts is forecast to slightly weaken after a very strong unexpected number last month - in the dead of the winter of all times !!!.

Currently, the housing market headlines and local real estate offered a very strong clue that the Spring selling season has failed. This is not different from forecasts by a homebuilder officials earlier in March. If a "rescue" from lower Fed rate is ruled out by fear of accelerating inflation in other non-housing sector, then I could imagine an even weaker consumer confidence because of wealth reduction from the asset side in the consumer balance sheet.

That leads to the other half of the equation. What will the stock market do, if my forecast were correct?

In the recent weeks, the market has:

a) rallied whenever "stronger" housing market headline is posted.

b) rallied whenever a higher probability of Fed cut is factored in. In other words inflation heads lower by way of weaker job picture.

The market reaction is indeed strange: the cut may happen as a response to a weaker housing market.

Let us for know accept a) and b) as being the way market thinks in the next few days. The upcoming inflation data cannot possibly help, and the housing headline has a very high likelihood of staying pessimistic.

A surprise of 50,000 extra jobs, in my opinion, will hurt more than help, on the margin. The extra income earned by the weaker population in the economy will be offset many times by the reduction in implied growth and higher cost of capital born by the stronger part of the economy.

The verdict: Next week may see a modest inflation-fear downtrade in the US stock and bond market. Next week may also see renewed fear in the housing market as local evidence points to a "bust" in the spring selling season.