Core Consumer Price Index was flat in May, below consensus estimate, therefore easing inflation pressures suggest that a soft landing for the economy is still achievable.

Highlights for This Week Include:

  • The Consumer Price Index (CPI) was flat in May, below the consensus estimate of a 0.1% rise and the softest showing since July 2022. Easing inflation pressures suggest that a soft landing for the economy is still achievable and gives the Federal Reserve (Fed) room to cut interest rates later this year.
  • Retail sales, industrial production, and small business optimism are all consistent with further economic growth which also bolsters the case for a soft economic landing.
  • Encouragingly, major U.S. stock indexes remain near all-time highs, and many market dynamics remain consistent with a risk-on environment (discussed below). Further economic growth supports the outlook for profit growth, which suggests that stocks remain well supported.

Easing Inflation Bolsters the Soft-Landing Case

The Consumer Price Index (CPI) was flat in May, below the consensus estimate of a 0.1% rise. It followed a 0.3% increase in the prior month and was the softest showing since July 2022. Core CPI, which excludes volatile energy and food, picked up 0.2%, the smallest gain since August 2021, and also below the consensus of 0.3%. On a y/y basis, the CPI eased to 3.3%, below the prior month and the consensus of 3.4%. Core CPI came in at 3.4%, the lowest inflation rate since April 2021, and below the consensus of 3.5%.

Alternative measures of core inflation also fell. The median and trimmed-mean CPI inflation measures from the Cleveland Fed fell to 4.3% y/y and 3.4% y/y, respectively—their lowest rates since at least January 2022, suggesting some broadening in disinflation. Easing inflation pressures suggest that a soft landing for the economy is still achievable. This also gives the Fed room to cut interest rates later this year, with the market now assigning the highest probability to two rate cuts later this year.

Retail Sales, Industrial Production, and Small Business Optimism Consistent with Further Growth

Retail sales edged up 0.1% in May, with the previous month revised down to -0.2% from flat. The modest decline so far this quarter partly reflects lower goods prices but also shows some softening in consumer demand. On a smoothed y/y basis, retail sales were up 2.9%, about the same as in the prior month and range-bound over the past year.

Compared to earlier in this cycle, retail sales growth has moderated, as excess savings have been nearly depleted and wage growth has eased. However, major consumption supports remain in place. Healthy payroll growth and low unemployment, helped by lower inflation, continue to support income and spending growth, even if it is at a reduced pace. This is consistent with the outlook for slower but positive economic growth.

Industrial production jumped 0.9% in May, the most in ten months, and more than double the consensus estimate of 0.4%. Manufacturing output rebounded by 0.9%, its first increase in three months. Most sub-industries posted gains, led by petroleum and coal products, wood products, and machinery, all of which rose by more than 2.0% from the prior month. Mining and utilities output rose 0.3% and 1.6%, respectively.

On a y/y basis, industrial production rose 0.4%, while manufacturing was up a smaller 0.1%. Although modest, the momentum in both series has improved, which is a positive sign for output growth and is consistent with further economic growth.

The NFIB Small Business Optimism Index picked up in May to its highest level this year. Although this suggests some improvement in business owners’ attitudes about the economy, the NFIB index has been range-bound over the past two years, hovering near its lowest level since early 2013. This subdued level of optimism suggests continued, but moderate, economic growth ahead.

The recent economic readings have the Atlanta Fed GDPNow model estimating a 3.1% second quarter economic growth rate while the Blue Chip consensus remains at 2.0%—both healthy readings.

Stock Market Performance

Encouragingly, the S&P 500 continues to make new highs. While near-term overbought conditions and narrow market leadership (weak breadth) make stocks more vulnerable to a pullback or correction, many market dynamics still suggest a risk-on environment.

Falling long-term bond yields, with the 10-year Treasury breaking below support levels, is a bullish signal for the broad stock market. High-yield bonds, historically a reliable harbinger of future economic turmoil, continue to signal a low probability of future defaults. Defensive sectors continue to underperform, consistent with a riskon environment. While broad-based market participation is most desirable, the weak breadth concern has not mattered for over a year, suggesting a poor timing tool.

In aggregate, first-quarter earnings were solid. Given healthy economic growth with easing inflation, as noted above, profit growth should continue, which provides the ultimate support for stock prices.

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