May Overview
Fed minutes from the last FOMC meeting highlighted a shifting policy tendency of the committee, from one with an “easing bias” to a more balanced two-way outlook for future interest rate decisions to account for persistently elevated inflation. While participants generally saw a potentially longer holding pattern until more certainty emerged on the economic implications from the Middle East conflict, the minutes shared that “many participants” would have favored a statement that removed an easing bias regarding future policy decisions. Indeed, although they supported holding the benchmark rate at its current level, three members dissented from the language in favor of a more balanced outlook going forward. Although “several” saw rate reductions as appropriate if “clear indications” of sustainable disinflation, or a weakening labor market emerged, a “majority” felt some “firming” may be appropriate if inflation persistently remained above 2%. As risks to the downside and upside for the labor market and inflation, respectively, remain “elevated,” an agile policy stance that allows the committee to move in either direction appeared warranted by the committee. 
The economy added +115K jobs in April, following a revised +185K in March. Healthcare jobs were the leader again, as they have been for some time. Other notable additions came from the retail, leisure, transportation and warehousing sectors. Despite household employment falling more than the decline in the labor force, it was not enough to move the unemployment rate from its 4.3% level. Elsewhere, JOLTS data showed job openings rising to their highest level in nearly two years, primarily in professional and business services, while hires, quits and layoffs decreased. Income-wise, average hourly earnings increased +0.2%, or 3.6% for the year, while real average earnings fell -0.3% for the year as inflation hindered growth. Similarly, real disposable personal income fell for the third consecutive month. Higher prices are impacting sentiment. The University of Michigan survey of consumers, which fell for the third consecutive month and now sits at an all-time low, highlighted the higher cost of living as a primary concern among respondents. The Conference Board’s measure underscored similar concerns with respect to rising inflation and its impact on consumers’ spending priorities. Despite this, headline retail sales gained +0.5% on the month, in part driven by higher gas spend at the headline level, although control group sales matched the gain, while the previous two months' data were revised upward, highlighting consumption growth continues despite negative consumer sentiment.
Industrial production rebounded in April, coming in at +0.7% for the month, and +1.4% for the year. The gains were driven largely by gains in the manufacturing sector (+0.6%), led by the motor vehicle and computers and electronics sectors, while utilities increased (+1.9%) and mining lagged. The ISM Manufacturing PMI increased and sits in expansionary territory for the fifth consecutive month after more than 3 years below 50, as new orders and production increased, and the prices paid index remained elevated despite sinking back slightly. With regards to higher prices, the NFIB small business economic trend report showed that small firms continue to deal with higher prices, with more firms sharing that they raised and/or plan to raise prices going forward and a growing percent sharing that inflation is one of the top issues they face. The optimism index still hovers below its long-term average and, although improving, still skews negatively in terms of profitability, while having a more reserved outlook for both sales and the economy. Firms seem slightly more inclined to increase capital expenditure in the coming months, a theme echoed by some, but not all, regional fed PMI surveys, which paint a mixed picture on the topic.
At the headline level, the monthly CPI report showed prices increasing +0.6% over the month, and 3.8% for the year. Energy remained a key contributor to the headline level, coming in at 3.8% for the month, but to a lesser extent than the previous month, while food inflation increase was also elevated at +0.5%. At the core level, prices gained +0.4% for the month, and 2.8% for the year. Core goods prices were flat, with increases in apparel, education and communication, alcohol and other goods offset by retracements in household furnishing, medicinal drugs, new vehicles and transportation commodities. Core services gained +0.5%, led by gains in shelter, though skewed by data collection difficulties during the government shutdown. Otherwise, a bump in airline fares also helped push the overall gain higher. In terms of personal consumption expenditures, headline and core PCE came in at 0.4% and 0.2% for the month, which equated to 3.8% and 3.3% for the year, respectively. Due to Middle East tensions, the Fed is concerned inflation may remain high. As a result, they are maintaining a cautious approach, keeping their policy flexible enough to respond to whatever the economic data dictates.
Capital Market Implications
The combination of ongoing concerns over the Middle East conflict, and persistently above target inflation, have increased uncertainty around the path of future Fed rate movements. Treasury yields rose, while equities gained as resilient earnings offset wider geopolitical risk concerns.
Capital Markets
Fixed Income Returns
With inflation persisting, the Fed signaled a shift towards a more balanced outlook for future rate decisions. Geopolitical conflict remains a risk, but the possibility of de-escalation helped support markets. Treasury yields edged slightly higher and credit spreads tightened.
Equity Total Returns
Equity indices rose in May, fueled by continued enthusiasm in the tech sector, better than expected earnings and hopes of a de-escalation in the Middle East conflict. The S&P, Dow and Nasdaq would all end the month at all-time high levels.
