It's 'show me' time for the economy, after April's monthly retail sales signaled the consumer is still alive and doing pretty well.
Consumer price index inflation data tops the list of economic reports in the week ahead, and is expected to show a year-over-year gain of 2.1 percent. The number is the next metric for Fed watchers, since inflation, as measured by the Fed's favored Personal Consumption Expenditures inflation gauge, continues to lag behind the Fed's target. Rising inflation would be a catalyst to push the Fed toward raising interest rates.
"It looks to me like the CPI is going to be a little hotter. There is a warming trend going on. It's going to be a little bit of a pickup year over year," said Diane Swonk, CEO of DS Economics. She said import prices are picking up and there have been increases in wages that should show up. Prescription drug prices and health-care services are also moving higher.
The strong 1.3 percent jump in April retail sales Friday, including a 2.1 percent bump in online sales, contrasts markedly with the dismal commentaries and earnings shortfalls coming out of chain stores in the past week. There are more retailers reporting in the week ahead, including Wal-Mart, Home Depot and TJX.
There's also a busy list of economic releases, with CPI the most watched. Industrial production is also released Tuesday, Fed meeting minutes are Wednesday and existing home sales Friday.
Stocks ended the week lower. The S&P 500 was down 0.5 percent at 2,046 and the Dow off more than 1 percent at 17,535, both below their 50-day moving averages for the first time since Feb. 29. Consumer discretionary was the worst performing sector and fell into negative territory for the year so far in Friday's close. Macy's, Nordstrom and others had sharp double-digit losses on the week. The XRT SPDR S&P Retail ETF was down 4.6 percent for the week.
"We're finally getting to the point where people are understanding that department stores aren't where we're shopping anymore," said Swonk.
The retail sales report showed that the consumer was in fact strong in April, buying cars and a whole list of other goods.
"I actually think we'll get surprised to the upside by second-quarter GDP," she said. She has a forecast now for 2.5 percent growth after a barely positive first quarter. "It could easily go up a bit with this retail sales number. The consumer is a big player. The consumer is still strong. They're motoring along. Vehicle sales are strong as well. They never left. The issue, I think, is the underlying economy. It's a change in the structure of the economy and a change in how we do things."
The retail sales figure comes after a 40,000 miss in April nonfarm payrolls to a below trend 160,000, and a surprise jump in Thursday's weekly unemployment claims, which soured views on the economy since employment has been a strong area.
Jim Caron, fixed income portfolio manager at Morgan Stanley Investment Management, said he expects the data to start showing consistent improvement since the improvement in financial conditions after January and February should start to show up in the economy. "I think those data points are ahead of us. They're not behind us anymore. I think the market is vulnerable to positive surprises," he said.
He said the move lower at the long end of the Treasury curve — in 10s and 30-year issues — after the strong retail sales number Friday bears watching. The front end, twos, threes, and five-year notes saw yields rise.
"I think the main driver of the back-end of the curve has to do with international events," Caron said in an email. "… the back-end of the U.S. curves provides less information about the domestic U.S. economy. Instead it explains more about international events. People are concerned that China stimulus is fading, European data (growth data released over night) was weaker and data in Japan remains soft. To me, this is why back-end yields are remaining low. Front-end U.S. yields reflect U.S. domestic economic activity, while the back-end reflects international financial conditions."
The first quarter's weakness may have also set up a scenario for markets, where "sell in May" does not work this year, he said in an interview. "Typically, you're long in the first quarter … and you see in May and you come back later in the year," he said. "I think the sequence of 'sell in May' is out of sync with the fact we didn't have a strong narrative in the first quarter."
As for the Fed, Caron does not expect the recent data is enough to get the Fed to move, and he sees the next rate hike in December. But Swonk said the improving data could put some pressure on the Fed at its June meeting, even if it is not expected to raise rates.
"[Fed Chair] Janet Yellen is going to have to use the press conference to re-set the market expectations that the Fed is going to raise rates," she said.
Fed officials, meanwhile, have been stressing in speeches that the Fed could raise rates. There are a few Fed speakers in the week ahead, including a press briefing Thursday by New York Fed President William Dudley. Dudley is viewed as the closest to Yellen, and his comments will be important.
Julian Emanuel, equity and derivatives strategist at UBS, said the CPI is the most important number for stocks in the coming week. "The whole issue here is basically we can live with a soft patch in the economy if in fact we believe that inflation isn't likely to accelerate," he said.
Emanuel expects the market to rally later in the year, but first it has to work through a number of issues, like the U.K.'s vote to leave the European Union June 23 and the present uncertainty around the U.S. presidential election.
"We think you're in for a choppy sideways period, until we see more evidence that the economy is not softening materially or we see a resolution of the political uncertainty at home or abroad, and we're not seeing that until at least the end of June," said Emanuel.
Caron said investors are holding back. "I think that the market has a very apathetic tone to it. It's not that it's complacency. People are plenty aware of the risks. ... It's just that people aren't willing to commit to anything. That's where the apathy comes in," he said.
What to Watch
Monday
Earnings: Agilent, Virtusa, Akorn
8:30 a.m. Empire State survey
10 a.m. NAHB survey
2 p.m. TIC data
5 p.m. Minneapolis Fed President Neel Kashkari
Tuesday
Earnings: Home Depot, TJX Cos, Red Robin Gourmet Burgers, Vodafone, Children's Place, Momo
8:30 a.m. CPI; housing starts; building permits
9:15 a.m. Industrial production
12 p.m. San Francisco Fed President John Williams, Atlanta Fed President Dennis Lockhart on a panel
1:15 p.m. Dallas Fed President Rob Kaplan
Wednesday
Earnings: Target, Lowe's, SAB Miller, Cisco, Hormel, Staples, Booz Allen, L Brands, Salesforce.com, Analog Devices, Burberry, Take Two Interactive
2 p.m. FOMC minutes
Thursday
Earnings: Wal-Mart, Gap, Applied Materials, Dick's Sporting Goods, Autodesk, Advanced Auto Parts, Ross Stores, Shoe Carnival, Mentor Graphics, Brocade
8:30 a.m. Jobless claims; Philadelphia Fed survey
10:30 a.m. New York Fed President William Dudley press briefing
Friday
Earnings: Campbell Soup, Deere, Foot Locker, The Buckle
10 a.m. Existing home sales