May headline came in below expectations. The annualized inflation rate is down to 4% and will likely make a lot of people feel as if the Fed has done enough, but is still a problem. It’s still been rising pretty consistently at a 0.4% month-over-month rate and proves that inflation concerns will be with us for a while. As long as growth remains positive, it’s almost impossible to imagine the Fed even thinking about rate cuts when core inflation is still running at a 5% annualized rate. If growth starts turning negative while core inflation is at 5%, then Powell might be forced to choose between the lesser of two evils. Until then, I think we’re almost certainly looking at a “higher for longer” monetary policy that lasts well into 2024.

With inflation generally setting investors’ minds at ease, despite some concerns, U.S. retail sales are up next. This one is concerning for me because if retail sales drop month-over-month in May, which is the current consensus market expectation, it would mark the 5th time in the past 7 months that sales have dropped compared to the previous month. Keep in mind that these are nominal numbers too. In real terms, retail sales are down about 4% year-over-year. Even as the economy manages to continue growing and wage growth is still up roughly 6% year-over-year, consumers continue to consume less and less. If consumer behaviour is getting weaker, home values are on the decline and the manufacturing sector is in contraction, these are not the kinds of conditions that suggest a soft landing or an indication that recession is likely to be avoided. Admittedly, the U.S. economy has held up for longer than I anticipated a year ago at this time, but I still think it’s unlikely that a recession won’t happen based on the signals that the economy is giving us right now.

In terms of market action I’m seeing, the remains ridiculously low, which is a short-term tailwind for risk assets. Small-caps continue to lead large-caps and I see a lot of people trumpeting the rotation as the next big trade. As I earlier this week, my intermarket analysis suggests this looks more like a rotation out of the mega-cap tech stocks that have gone nuts over the past month, not necessarily a rotation into small caps. Most market sectors have outperformed the over the past couple of weeks, including utilities, and the value-over-growth trade, which usually coincides with small-cap outperformance, has been virtually non-existent. If this is a true small-cap rally, it’s missing some of the markers that typically come with it. I think this bounce sucks a few more performance chasers in before it starts turning upside down later this summer.