The stock market may have an opportunity to claw back some of its recent losses over the next few weeks, as the Fed is in the background until the March 15-16 FOMC Meeting. Nevertheless, the macroeconomic/Fed background for the stocks continues to be unfavorable after Fed Chair Powell's post-FOMC news conference last week. Economic growth has to slow to trend or lower and the Fed will tighten -- possibly aggressively -- to ensure this will happen.
Fed Chair Powell seemed at the start of the news conference to want to downplay a hawkish turn in Fed policy. He began by emphasizing the dual mandate of the Fed -- to achieve maximum employment and keep inflation at bay. And, he acknowledged downside risks to the economy from the Omicron variant of the virus and the downshift in fiscal stimulus. But, as the conference progressed, he argued that fighting inflation will be the primary focus of policy. He downplayed the risk of recession by citing forecasts of above-trend growth this year. While he talked about temporary factors contributing to inflation, he did not see them ending soon. As a result, he suggested that Fed rate hikes will be more pronounced than in recent episodes.
Although Powell did not go beyond pointing to a rate hike in March, it would seem that the magnitude and frequency of rate hikes in this cycle will depend on achievement of a sustained GDP growth slowdown to 2% trend or lower and/or a decline in inflation to the Fed's 2% goal. A string of 25 BP rate hikes at each FOMC Meeting, beginning in March, may be needed.
The sustainability of slow growth is important. Powell expects GDP Growth to slow in Q122, but for temporary reasons -- e.g., China's anti-virus lockdown policy and virus-caused job absenteeism in the US. He sees economic growth picking up this Spring. His view means that soft US economic data for the January-March period will not deter the Fed from beginning to hike at the March FOMC Meeting. What will be important is whether US economic data remain soft this Spring. Street forecasts, as well as the Fed's Central Tendency Projections, for 2022 will be important, too. If forecasts come down toward 2% Real GDP Growth, the Fed could pull back from aggressive tightening.
While the Fed would presumably like to see a "soft landing," with Real GDP growth slowing to trend, the typical way monetary policy fights inflation is by pushing growth below trend in order to create labor market slack. This may not be necessary if the supply side expands capacity by itself. Here are three possibilities: /1/ An ending of shortages and supply disruptions results in increased supply, resulting in lower inflation. There are already a few signs that supply disruptions are easing. Besides comments in manufacturing surveys, Friday's release of Q42 Real GDP showed a jump in inventory investment. In particular, the motor vehicle industry stopped drawing down inventories, suggesting that vehicle prices may soon be coming down. /2/ An increase in labor force participation would mitigate the need for monetary policy to create slack. This may happen if the virus becomes less of a problem. But, an increase in participation while the economy is slowing may be a long shot. /3/ Labor-saving technology and more efficient production processes could hold down costs and thus prices.
This week's US economic data loses some significance, given Powell's likely dismissal of Q122 soft prints as temporary. Consensus expects a dip in the January Mfg ISM to 57.5 from 58.7. This would be the lowest level since November 2020, but still historically high. Consensus sees +200k m/m January Payrolls, about the same as the +199k in December. (Note, this report contains benchmark revisions for Payrolls going back 3 years.) Consensus also sees a steady 3.9% Unemployment Rate. The Claims data suggest a dip, however. Perhaps the most important part of the Report will be Average Hourly Earnings (AHE). Consensus expects a slight slowdown to +0.5% m/m from +0.6% in December. This is still a high pace, however. AHE rose 0.4% m/m in 6 of the past 8 months -- which, itself, is high.
Evidence regarding Payrolls is mixed. The Claims data suggest a weaker print than December's. But, they missed in December, and there could be catch-up after December Payrolls were far below the ADP Estimate. (An upward revision to December is also a risk.) Moreover, seasonals look to offset post-holiday layoffs in Retail and related sectors -- which could result in a rebound in these jobs. Since there was less-than-normal holiday hiring in Q421, there should be fewer-than-normal layoffs.
The White House has pointed out that the Omicron virus could depress Payrolls this month. If a person were not at work for the entire survey week and not paid, he/she would not be counted in the Payroll figure. The important point here is that such individual was not paid for the entire survey week, not even for just one hour. Just looking at the number of people who were not at work because of illness probably overstates the subtraction from Payrolls. But, if the print looks very weak, this is what market analysts will say and dismiss the figure. The virus' impact should have a smaller effect on the Unemployment Rate than Payrolls. The Household Survey, which the Rate is based on, asks whether a person was employed, not whether he was paid. It counts as employed people who are on unpaid leave from their jobs.
If unpaid leave does appear to be the reason for very weak Payrolls, it also could result in a jump in Average Hourly Earnings. Presumably, lower-paid workers are those who are not paid if they don't show up for work because of illness. So, a compositional shift toward higher-paid workers could boost AHE. A high AHE should be dismissed if it accompanies a very weak Payroll print.
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