Easier Fed Policy This Week

The stock market may continue to climb this week, helped by strong corporate earnings and easier Fed monetary policy.  The Fed is likely to cut another 25 BPs in the funds rate as well as end its bond sales.  Last week's softer-than-consensus September CPI provided more reason for the Fed to be comfortable with policy moving in this direction.  A potential meeting of Chinese President Xi Jinping and President Trump ahead of the latter's threat of an additional 100% tariff could be important for the stock market, as well.

The modest September CPI -- with Total up 0.3% m/m and the important Core up only 0.2% -- should encourage the Fed's belief that its 2% inflation target will be hit eventually.  Boosts from tariffs were still evident, but they did not dominate.  Most of the major Core components, specifically 9 of 15, had prices rising by 0.2% or less.  And, the important Owners' Equivalent Rent (OER)  slowed sharply to 0.1% from its 0.3% trend.  A continuation of this low trajectory would be a significant step toward the Fed's overall inflation goal.  Some private surveys say that rents are falling.  It isn't clear whether the rent declines seen in these surveys are behind the OER slowdown, since the CPI's measure of rents is lagged.  However, if the private surveys are right, they bode well for OER to stay low in future months.  The y/y for both Total and Core CPI was 3.0% in September.  Total has to average under 0.31% m/m during Q425 for the y/y to fall by December.  The Core CPI has to average under 0.25%.

Fed Chair Powell in a recent speech raised the likelihood that the Fed would end its balance sheet reduction program in the near term.  Although he was not specific when this would happen, the soft September CPI would seem to be enough of a reason to do so at this week's FOMC Meeting.  Such a move should be particularly helpful for the housing market, as mentioned in last week's blog.  To repeat, much of the Fed selling has been of mortgage-backed securities.  The spread between mortgage rates and Treasury yields, which has been historically wide, should narrow with the ending of this program.   Mortgage rates would fall by more than would longer-term Treasury yields. 

The other important event this week will be the possible meeting of Trump and Xi Jinping in South Korea on October 30.  Even though Xi appears to have survived the internal political infighting at the Fourth Plenum, some analysts believe he has lost power -- possibly to more pro-Western factions -- within the government and armed forces.  Whatever the case, he appears to be open to a conciliatory approach to US-China trade issues, possibly as a result of the weakening economy and rising unemployment in China.  Pre-talk negotiations between the US and China are reported to have agreed upon a framework for the Trump-Xi meeting.  

 

 

 

 

 

 

Profits, Fed, CPI and China

The stock market should continue to be buoyed by strong corporate earnings reports this week.  It also should be supported in the background by the Fed's intention to broaden its easier policy stance by ending its selling of long-dated securities.  The September CPI will be released this week, despite the government shutdown.  The consensus estimate, while a bit high, should not deter the Fed from cutting rates at the October 28-29 FOMC meeting.  

The more immediate meeting with potential importance for the markets is this week's Fourth Plenum of the Chinese Communist Party.  The question is whether rumors and circumstantial evidence of a power shift away from Xi Jinping to more pro-Western leadership, as reported in podcasts, bear out.   This week's meeting of Treasury Secretary Bessent and the Chinese Vice Premier He Lifeng to attempt diffusing the trade fight may be suggestive of such an outcome.

The Fed appears to sticking with its easing plans, despite the absence of almost all hard data on the economy as a result of the government shutdown.  It does have clues on the state of the economy.  It sees private surveys, like the weak ADP Jobs Estimate and its own surveys, like the Beige Book.

The October Fed's Beige Book, which summarizes anecdotal evidence collected by the District Fed Banks, does not appear to make the Fed's decision easy.  It suggested softer economic activity but higher inflation.  However, the Fed has shifted its focus toward the risk of a soft economy, viewing the higher inflation as being boosted temporarily by tariffs.

The Book had a slightly soft tone regarding economic activity, thereby supporting easier policy.  Four of the Districts reported a slight softening in activity, while three reported slight to modest growth.  Five Districts reported no change.  Regarding the labor market, most Districts reported lower headcounts, stemming from layoffs and attrition.  Weaker demand, economic uncertainty and AI were blamed.  The overall tone of the report sounded more like sluggish growth than recession.  Nevertheless, labor costs have sped up, largely reflecting large increases in employer-sponsored health insurance premiums.  And, tariffs contributed to a speedup in input costs.  There was varied reports of the extent to which the higher tariffs were passed through to the consumer.  

Consensus looks for +0.4% m/m Total CPI and +0.3% Core, to be released on Friday.  These increases would be above the Fed's 2% inflation target, as their annualized increases are 4.9% and 3.7%, respectively.  The y/y, which the Fed looks at, would be 3.1% for Total (versus 2.9% in August) and 3.1% for Core (the same as in August).  The Fed views these 12-month changes as slightly on the high side.  Despite being on the high side, consensus-like prints should not be a problem for the markets or Fed because tariffs will likely be blamed but viewed as temporary.  Moreover, there is a possibility that Total and Core will print below consensus.   For example, if Used Car Prices and Lodging Away From Home flatten out after their August jumps, Total risks being 0.3% and Core 0.2%.

Despite the mixed message from the Beige Book, public comments by Fed officials point to further rate cuts.  For example, Fed Governor Miran wants a 50 BP rate cut but thinks a 25 BP cut is likely.  Governor Waller wants a 25 BP cut at the October FOMC Meeting, but is unsure about subsequent moves (being dependent on the course of the economy).  Fed Chair Powell kept the door open for more rate cuts in his latest speech.

Besides another rate cut, Powell indicated that the Fed is close to stopping its program of selling its bond holdings.  This stoppage, a broadening of the easing policy, could be an important positive for the housing market since much of the Fed selling has been of mortgage-backed securities.  The spread between mortgage rates and Treasury yields, which has been historically wide, should narrow with the ending of this program.   Mortgage rates would fall by more than longer-term Treasury yields. 

 

 

 

  

Trade War or Chinese Politics?

The stock market may begin recovering from Friday's sell-off as favorable earnings reports take precedence for now over Trump's pending imposition of 100% tariffs on Chinese imports.  The mystery in this latest confrontation between the US and China is not Trump's tariffs but China's new restrictions on rare earth exports that triggered Trump's action.  On the surface, China's imposition of new restrictions didn't make sense, given that a trade agreement was being worked on and a meeting between the two countries' leaders was being discussed.  My conjecture is that Chinese politics was behind the new restrictions and that the whole issue could be resolved after the Fourth Plenum of the 20th Chinese Communist Party on October 20-23. 

According to podcasts by Chinese political observers, several groups among the Chinese leadership have been maneuvering to end Xi Jinping's rule as president.  Some of these groups want to improve China's ties with the West.  The observers cite circumstantial evidence.  For example, high-level people who were aligned with Xi Jinping have been removed from their government positions, while others who had been removed by him are back in power.  These observers say Xi Jinping could resign, citing health reasons, or could stay president as a figurehead with the opposition holding the real power.   Whatever the outcome, it could be resolved at this Plenum.

Like a le Carre spy novel, it's not clear which side -- the anti- or pro-Xi side -- is behind the new restrictions on rare earth exports.  The anti-Xi side could have wanted to demonstrate that taking an aggressive stand against the West would trigger large negative retaliations, counting on Trump's impulsiveness to implement them.  They would use this evidence to discredit Xi Jinping's anti-West stance.  The pro-Xi side could have wanted to create a situation, with the country under attack or stress, requiring continuation of the current leadership -- typical of government leaders who find themselves in personal difficulty.  

In any case, the motivation of the Chinese leadership to allow the 100% tariff to hurt their economy should end once the power struggle is decided at the Plenum.  So, if, indeed, the latest flare-up in the US/China trade war results from Chinese internal politics, there could be movement to resolve the problem after the meeting.  The rare earth restrictions and the 100% tariffs could be rescinded.  Movement in that direction could be seen in the last week of October -- before the 100% tariffs go into effect.

 

 

 

       

Trending Up Into Corporate Earnings

The stock market may trend up into the corporate earnings season, as the latter is expected to be strong.  Although the government shutdown prevents the release of economic data (and presumably the collection of data for subsequent reports), the stable longer-end of the Treasury market and dollar indicate little change in the overall picture -- modest growth and contained inflation.  The latest ADP Estimate suggests a weak September Employment Report, but there is mixed evidence.  The stock market impact should be subdued even if the eventual September Payroll print confirms ADP.  The prospects of multiple Fed rate cuts would balance fears of recession.  

Fed monetary policy should not be affected by the government shutdown if the latter is short in duration.  Any drag stemming from it would be viewed as temporary.  Monetary policy could be pushed to further rate cuts if the Administration uses the shutdown as an excuse to permanently cut financial support for infrastructure building or other forms of government spending, such as subsidy or transfer payments.  It is too soon to say whether this will be the case.  The cutbacks announced so far may end with the shutdown.

The September CPI, when it does get released, looks like it should be in line with the prints of the past few months.  Total looks to be a little on the high side, up 0.3-0.4% m/m.  Core looks to be contained at 0.2-0.3%.  Some of the increase in the CPI could be viewed as temporary.  This is the case for boosts from tariffs, the impact of which the Fed thinks is likely to be one-time.  However, other components remain stubbornly high.  In particular, Owners' Equivalent Rent remains in a 0.3-0.4% range.  It needs to get down to 0.2% for the Fed to be successful in achieving its 2% inflation target.  Failure to do so, along with a desire to prevent a wage-price spiral developing from tariffs, could keep Fed monetary policy in a somewhat restrictive stance even after some rate cuts.

The labor market looks soft according to private surveys, such as ADP.  It put September Private Payrolls at -32k m/m.  ADP did a better job than the Bureau of Labor Statistics (BLS) First-Print Payrolls in predicting the final print for a month from March through June (see table below).  It missed in July, but the BLS data for that month will be revised in the September Employment Report.  So, it's too soon to say which was a better predictor of the final print for August.  

There is mixed evidence regarding September Payrolls.  ADP suggests a weaker BLS print in September than in August.  However, the Claims data suggest a speedup.  If the eventual Payroll print confirms a decline like ADP's, talk of recession and 2-3 Fed rate cuts in Q425 could heat up.  The prospect of substantial Fed easing should offset concern about recession, allowing the stock market to be little damaged by a weak September Employment Report.  Alternatively, a soft Payroll print could be the fall-out of AI and other efficiency drives by companies.  In this case, GDP may not indicate recession but strong productivity growth.  The latter would help lift corporate earnings -- a positive for stocks.

There is also the possibility that higher unemployment will free up resources to meet the needs for the investments and production being re-shored.  It would allow the re-shoring to proceed without putting upward pressure on inflation.  This would be good for the longer-term market outlook.

                                            Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS         

    March               155                          209                            120

    April                   62                          167                            133

    May                    37                          140                              69          

    Jun                    -33                            74                              -27                                    

    Jul                    104                            83                               77     

   Aug                     54                            38                                na                            

   Sep                    -32                            na                                na

 

  

   

  

 

 

 

 

Caution Ahead of Key US Economic Data and Govt Shutdown?

The stock market may continue to trade cautiously this week as the federal government risks a shutdown and key US economic data are not expected to change the overall picture.  However, there is reason to think these factors may be taken in stride.  Both the September Mfg ISM and Nonfarm Payrolls are seen improving somewhat from their August prints.  However, their improvement is expected to be modest and should not change the markets' probabilities of further Fed easing.  A more positive market tone could reemerge afterwards as Q325 corporate earnings are released.

Consensus looks for Nonfarm Payrolls to rise by only 39k m/m, versus +22k in August.  However, the latest Unemployment Claims data suggest the risk is for a somewhat larger increase.  Consensus estimates for the other important parts of the Employment Report are more of the same: a steady 4.3% Unemployment Rate and 34.2 Nonfarm Workweek, and 0.3% m/m Average Hourly Earnings.  Rounding analysis suggests a better chance of a 3.4% than 3.2% Rate.  The unrounded Unemployment Rate was 4.32% in August.  Consensus prints shouldn't change the Fed's view of the outlook -- still cautious but not overly concerned about the economic outlook.

Consensus looks for the September Mfg ISM to edge up to 49.2 from 48.7.   This would remain at a level suggesting modest economic growth.   It would be a bit below the 49.4 H125 average.  Real GDP Growth averaged 1.6% (annualized) in H125.

The stock market has not liked government shutdowns in the past.  However, it may be different this time for two reasons.  The long end of the Treasury market appears to be sensitive to large shifts in the 10-year projection of the Federal Deficit, as seen in a rise in yields when the courts threatened an end of Trump's tariffs.  The government revenue impact became more important as the inflationary impact has so far been modest.  The markets may view a shutdown as a way that Trump will cut government spending.  And, it would prevent the renewal of some government subsidies being pushed by Democrats.   

Consensus looks for about 7.5% (y/y) growth in Q325 corporate earnings.  This is below the 12.0% seen in Q225.  However, it is still strong.   And the consensus estimate tends to be too low, so a stronger quarter is conceivable.  The macro evidence supports this risk.  Real GDP Growth sped up on a y/y basis,  based on the Atlanta Fed model's estimate for Q325.  The dollar weakened as economic activity abroad improved.  Both boost earnings made abroad.  There is a possibility that domestic profit margins improved, as the Core CPI climbed by more than Average Hourly Earnings.  Although some of the strength in the CPI reflects tariffs, which don't lift profits themselves, they offer domestic producers room to increase profit margins.  Finally, there should be a smaller drag from oil companies. 

                                                                                                                                      Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)

 Q124            2.9                +14.0                  0.0                              4.3           3.8              46.4 

Q224            3.0                  +2.5                +3.0                              3.9           3.4               46.3 

 

Q324            2.7                  -6.0                 +2.5                              3.8           3.2               45.3     

 

Q424            2.5                   0.0                 +3.5                              4.1           3.4               45.4       

 

Q125            2.1                  -6.5                +6.0                               3.9           3.1               47.6                                       

Q225            2.0                -16.0                +3.5                               3.9           2.8               49.3     

 

Q325            2.2                -11.0                -1.5                                3.8           3.1               50.0                 

                                                                           

* Based on the Atlanta Fed Model's latest projection of 3.9% for Q325 (q/q, saar).

 

A Growth-Friendly Fed

The stock market should continue to be buoyed by a growth-friendly Fed.  The 25 BP rate cut shows the Fed will respond to economic weakness.  And, the "dot" plot indicated a leaning toward further easing by most members of the FOMC meeting.  Fed Chair Powell and other Fed officials will likely reiterate the Fed's new emphasis on the downside risks to the economic outlook in speeches this week.

Soft US economic data, in real terms or inflation, should support expectations of further Fed easing and thus be positive for the stock market.  And, most of this week's US economic data are expected to be on the soft side.  Consensus looks for August Durable Goods Orders to dip, both in Total and Ex Transportation.  It also expects declines in August New and Existing Home Sales and a rebound in Initial Unemployment Claims.  The August PCE Deflator is seen up a modest 0.2% m/m for Core.  However, August Consumption is expected to rise 0.5% m/m -- a  decent gain even after adjusting for inflation.

The Fed expects modest economic growth and a temporarily higher pace of inflation into early next year, according to Fed Chair Powell at his post-meeting news conference.  The 1.4-1.7% Central Tendency Forecast for 2025 (Q4/Q4) implies 1.4-2.0% Real GDP Growth for the second half of the year, given the 1.4% growth in the first half.  If the Atlanta Fed Model's estimate of 3.3% for Q325 Real GDP and the Central Tendency forecast are right, then Real GDP has to weaken t o -0.5% to +0.7% (q/q, saar) in Q425. Except for a possible recession in Q425 in this scenario, the annual Central Tendency forecast is at or slightly below the Fed's estimate of longer-run growth.

Such a growth pace would likely be acceptable for the stock market inasmuch as labor costs should remain contained.  Powell acknowledged that wage inflation has moderated and that both labor demand and supply have fallen.  Although the pass-through of tariffs has been slower and smaller than the Fed expected, it still sees the tariffs to be more fully passed through over time -- a positive for the path of corporate earnings.  Specifically,  the Fed looks for the tariffs' boost to prices to grow through the rest of the year and possibly into 2026.  

The future path of monetary policy will depend on economic developments ahead, but the likely direction is for lower rates.  Although there was only one vote for a 50 BP rate cut at last week's FOMC Meeting, nine of 19 participants look for 2 or more 25 BP cuts this year.  There are reasons to expect a persistence of the current combination of modest growth and moderate inflation for the rest of the year, supporting more rate cuts.  The slowdown in immigration has been a major factor holding back labor force growth (and a negative for demand for goods and services).  This restraint is not going away.  And, besides modest wage inflation, most measures of longer-term inflation expectations continue to be consistent with the Fed's projections, according to Powell.   This is not the case, however, with the University of Michigan Survey's 5-Year Inflation Expectations figure, which, at 3.9% in mid August, is well above its 3.0-3.2% pre-tariff range.  The final print for the month will be released this week.

A rising stock market would be desirable for the Fed, since it is a major channel (via consumption) through which easier monetary policy supports the economy.  Lower short-term rates also help through the reduction in borrowing costs on credit cards and auto loans.  However, the channel through lower longer-term yields may be hampered in the near term by their being lifted by the variability of short-term rates and the dollar.  They raise the risk premium in the term structure of interest rates.

 

 

 

 

A 25 BP Fed Rate Cut, More To Come?

The stock market rally should be sustained by this week's FOMC Meeting.  Besides a 25 BP rate cut, the Statement or, more likely, Fed Chair Powell could signal that more easing will be coming if needed.  And, this week's US economic data are expected to keep that possibility alive by underscoring a sluggish growth pace.

A Fed easing path will likely embody a number of 25 BP rate cuts.  There are several reasons to expect such a cautious path.  First, inflation remains higher than target, with the culprits including more than just tariffs.  In particular, housing rent (primary and owners' equivalent rent) continue to run 0.3-0.4% m/m.  It likely needs to slow to 0.2% in order for the Fed to hit its 2% inflation target.

And, tariffs remain a problem for the inflation fight, although there were some signs of a moderation in their impact in the August CPI.  A jump in Food Prices At Home in August may have been caused in part by tariffs.  The unusually large 0.6% in these prices most certainly is a factor behind the depressed level of consumer confidence.  In contrast, Household Furnishings and Recreational Commodities flattened out after a couple of months of large increases, suggesting the impact of tariffs on them is settling down, in line with the Fed's best guess that the tariffs will have a one-off impact on inflation. 

Nevertheless, the Fed may be concerned by signs that longer-run inflation expectations have ratcheted up.  The University of Michigan Consumer Sentiment Survey shows 5-year inflation expectations at 3.9%, well above the 3.0-3.2% range seen before the start of tariffs.  

As a result, allowing a somewhat softer labor market for a while may be optimal monetary policy in the context of tariffs.  It would prevent a wage-price spiral from developing by dissuading labor from bargaining for higher wages to offset the loss of purchasing power.  The Fed would never admit to this reason.  However, Powell acknowledges that wage inflation has not been a source of inflationary pressure, showing that Fed officials are cognizant of this potential.

A sluggish pace of economic growth is expected to be apparent in this week's US economic data releases.  Consensus looks for a slowdown in Retail Sales to 0.3% m/m in August from 0.5% in July.  Ex Auto Sales are seen repeating July's modest 0.3% increase.  This gain is even smaller in real terms, that is once inflation is taken into account.  Consensus sees flat August Industrial Production after -0.1% in July.  There is downside risk from a likely decline in Manufacturing Output after a flat July.   Consensus expects little m/m change in August Housing Starts and Permits.