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Surprise! The bad economic data is turning

Traders work on the floor of the New York Stock Exchange.
Lucas Jackson | Reuters
Traders work on the floor of the New York Stock Exchange.

For weeks, Wall Street forecasters missed the mark on one economic report after another, giving credence to the view that winter weather was not the only thing holding back the economy this year.

But the negative data stream appears to be turning, with more big numbers coming in stronger-than-expected - including recent beats on the consumer price index, ISM manufacturing, housing starts, new home sales and construction spending.

Traders have been tracking this change in data via the widely-followed Citigroup Economic Surprise Index, which appears to be bottoming.

Source: Citigroup

The index measures the actual data against economists' expectations, and recently it has been turning higher as the number of 'beats' picked up.

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If this trend persists, traders would expect to see higher yields and choppier trading in stocks.

The turn in the index, however, may not mean that the economy is doing remarkably better. It may just mean that economists just lowered the bar.

"You can either get it because the data is better or because consensus has moved lower. My opinion is that consensus has moved lower," said John Briggs, head of strategy at RBS.

Even if the positive surprises only create a perception that the data is improving, that could still be bearish for bonds and send yields higher. Stocks should fare okay, unless the data really improves and moves up expectations for Fed tightening, Briggs said.

"Sometimes all that matters for Wall Street is the momentum of expectations, not the momentum of the economy, from an investment perspective," said James Paulsen, chief investment strategist at Wells Capital Management.

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But that could be negative for stocks, as traders watch for any thing that could move up the timing of a Fed rate hike. Many economists expect the Fed to begin raising rates in September, or December.

"I think that we've turned the corner in the United States to where good news is bad news, and my guess is we can't handle a lot more good news," said Paulsen. He said an improvement in the Citi index could mean choppier stock trading ahead.

Paulsen, however, does believe the economy is improving, and that could even show up in a better-than-expected May jobs report this Friday.

"At the end of the day, there's a pretty high correlation of whether the economy is doing better or not with that surprise index," he said.