Budget Deadline Pushed To May 5th

Stocks sold off on Friday despite the earnings beats from Amazon and Alphabet on Thursday afternoon. They helped the Nasdaq be the best performing index for the day as it was down 0.02%. Because the big technology firms have no impact on the Russell 2000, it fell 1.18%. The weak GDP report was the negative news which dragged stocks lower. Stocks also have a strange losing streak on Fridays as the last Friday the stock market was up was March 10th. Stocks being down six Fridays in a row doesn’t signal anything to me, but I figured it’s worth noting.

Budget Deal

There was good news on the legislative front Friday as the Democrats and Republicans agreed to a temporary stopgap budget which lasts until May 5th to prevent the government from shutting down. On face value, that is a ‘nothingburger’, but when you look at the details, you can see that a real budget will be agreed upon shortly. As I predicted, the Republicans agreed to fund the cost-sharing reduction payments to insurance providers to subsidize low-income healthcare plans. This was the main goal Democrats wanted to achieve in these negotiations. The budget needs 60 Senate votes to pass, so they needed to be convinced to get on board. It wasn’t surprising that the GOP changed its position because it is better politically to come up with a new plan instead of taking funding away from low-income people who would have had their premiums raised, if nothing was done.

Trump’s Fed Chair Pick

The latest rumors on who Trump will pick as Federal Reserve chairperson suggest that he’s considering selecting Gary Cohn who is the Director of the National Economic Council and Trump’s closest economic advisor. The reason why Trump wants to select Cohn tells us what his frame of reference will be no matter who he picks. Trump likes Cohn because he’s in favor of deregulating the banks and low interest rates. Usually Presidents like low interest rates because they lower deficits which allow the government to spend more money on fiscal policies. Spending money on fiscal policies isn’t the most efficient way to boost the economy, but it is the best politically because the President gets to point to specific policies which he implemented to improve growth.

While Presidents usually like low interest rates, Trump has been much more explicit in his desire to keep rates low. This changes the ball game. It’s as if Trump added a third mandate that the Fed must keep rates low to prevent deficits from getting out of control. With inflation expectations rallying based on Trump’s expansive fiscal policies, the narrative that there would be a handoff from economic reliance on monetary policy to fiscal policy gained traction. However, the monetary policy is the backbone to the ability to spend money on deficits. It may be Trump’s style to explicitly state things which are implicit or it may be that the deficits have gotten so large that the Federal government must admit its reliance on low interest rates in a desperate manner.

To be clear, Trump is considering not picking Cohn because he wants him to work on crafting economic policy. The other potential chairs are Kevin Warsh who is a former Fed Governor and FDIC vice chair Thomas Hoenig. Trump’s pick in February will start to alter how the market prices in rate changes, but it is slightly too early as of today. The market is currently split between expecting one and two rate hikes. There’s a 37.3% chance rates go up by exactly 25 basis points and a 36% chance rates go up by exactly 50 basis points. There’s a 51.1% chance rates are hiked by at least 50 basis points. There was only about a 1% move in the various odds for rate hikes on Friday even though the GDP report was very weak. It shows how the market knows the Fed isn’t data dependent. Technically bad economic data may cause more rate hikes because the Fed may feel its window to raise them before the next recession is closing. That concern is valid as the Fed has only raised rates 75 basis points this cycle and the economy is stagnating.

Consumer Spending

Consumer spending has been weak on an aggregate basis as PCE was up 0.3% in Q1. You cannot spin this positively by claiming that online stores are taking share from brick and mortar stores because online sales are included in the PCE. That’s like claiming a baseball team with a losing record had a good season because one player hit 40 home runs. The chart below shows the latest non-seasonally adjusted online retail sales growth on a year over year basis. Usually there’s a spike at the end of the cycle as consumers notice the economy is weak, so they start shopping online to save money. Online stores have a tough time earning decent margins because it’s so easy to find the best price on items. As you can see in the chart, when the economy starts to falter to the point of being in a recession, even online sales growth falls below zero. The latest weakness in online sales could be signaling a recession, but there have been two head fake declines this cycle, so it’s not close to a done deal.

Conclusion

The economy may be terrible, but at least the government won’t shut down and Alphabet had a great earnings report. Surprisingly the weak GDP report pushed stocks lower. I say it’s surprising because stocks have ignored the fundamentals of the economy. This weak report certainly challenges the optimistic thesis, but the bulls have been unwavering in their willingness to buy stocks. The GDP report is the easiest to forecast because it is showing how the economy did in the past 3 months of which we have had a deluge of data on. It’s much tougher to predict monthly economic reports. The next report I will be focused on is the first revision to Q1 GDP which will be released on May 26th. Then I will shift focus to how Q2 is shaping up