The massive decline in the stock market last week can be understood as an adjustment to a worsened outlook of slower economic growth and tighter monetary policy The question now is whether Powell and the Fed can calm the market at this week's FOMC Meeting. One way could be to emphasize that the Fed is pro-growth as well as anti-inflation in intent, implying a gradual approach to tightening.
The FOMC Statement will likely be more hawkish than in December, but this new tone should be viewed as old news. It should point to a 25 Bp rate hike at the next meeting in March, which is the consensus expectation in the market. The last Statement said "the Committee expects it will be appropriate to maintain this target range [0 to 1/4% funds rate] until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment." These conditions have been met. The 3.9% December Unemployment Rate is certainly consistent with the idea of full employment. While the sub-300k m/m increases in Nonfarm Payrolls in November and December disappointed market observers, in fact they exceeded the pace estimated to be consistent with a steady unemployment rate.
What would be a shock is if the Statement stops partly attributing the recently high inflation to temporary factors. Doing so would signal the need for more aggressive tightening than generally thought for the rest of the year. But, to avoid this signal and also because it is correct, the Fed will not likely stop saying this. The Statement should repeat that "Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation." A repetition of this sentence would highlight the role of temporary factors behind inflation and could help the market.
Powell could help the market in his post-meeting news conference by emphasizing that the Fed does not want to derail the economic expansion. It intends to move policy on a measured, well-communicated path. In particular, shrinking the Fed's balance sheet is most likely later in the year. And, the Fed will be mindful of signs of weakness as well as inflation. It would be disappointing, to say the least, if the Fed's earlier goal of bringing the Unemployment Rate back to pre-pandemic levels is quickly reversed -- which would be the case if it tightens aggressively.
A rate hike at this week's meeting is unlikely. It would signal that the Fed has become more concerned with the inflationary bent of the economy -- which would push financial markets to tighten even more and do real damage to the economy. This is a result the Fed presumably does not want. Evidence of slower economic growth already is building. Both Initial and Continuing Claims rose in the latest week. And, the January Empire State and Phil Fed Mfg Survey showed that the manufacturing sector has slowed from its H221 pace.
While this week's US economic data contains the first print of Q421 Real GDP Growth (consensus 5.4% q/q, saar), the market already has moved past last year's strength. The more important data will likely be January Conference Board Consumer Confidence and December Durable Goods Orders -- evidence on the current state of the consumer and a forward-looking indicator of manufacturing activity. Consensus looks for a decline in Confidence to 111.8 from 115.8. The Index averaged 112.3 in Q421. Consensus expects -0.5% m/m for Durables, after +2.5% in November. Ex Transportation Orders are seen at +0.4%, vs +0.8% in November. These estimates are consistent with the idea of slower growth, but the risk is probably to the downside. While weak prints would likely hurt the stock market initially, they could be viewed in a more positive light if understood to be restraining factors on Fed policy.
This week's key inflation data are the December PCE Deflator and Q421 Employment Cost Index (ECI). Consensus looks for +0.6% m/m Total and +0.5% Core PCE Deflator. This is in line with the already released CPI (although the +0.6% Total PCE Deflator seems to be a little too high) and not new news. Consensus expects +1.2% q/q in the ECI, versus 1.3% in Q321. Such a print would be historically high even though it is lower than in Q321. It will underscore that wages are a problem in the inflation outlook.
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