Stock Rally to Continue This Week?

The stock market may continue to recover this week, as the risk is for a softer-than-consensus January CPI.   A softer CPI could temporarily counter the implications of the January Employment Report and take pressure off the Fed to tighten aggressively at this point.

The January Employment Report did not dispel concerns of potential aggressive Fed tightening.  Besides strong Payrolls, the uptick in the Unemployment Rate was not enough to be statistically significant.  Moreover, the increase in Labor Force Participation could have reflected the "small sample bias" of the Household Survey.  The sample may have just captured a lot of people who were in the labor market.  So, it is too soon to say the increase in the Rate is meaningful in terms of giving the economy more room to grow without inflation.  Indeed, the broader U-6 measure of labor market slack fell in the month.

Nevertheless, the Report did suggest a slowdown in economic growth at the start of Q122.  The clearest sign was the drop in the Nonfarm Workweek -- possibly impacted by the Omicron virus as many workers stayed home for part of the Survey Week.  It resulted in a decline in  Total Hours Worked, despite the surge in jobs.  The January level of THW is flat relative to the Q421 average, pointing to slower Q122 Real GDP Growth.  Although too early to be meaningful, the Atlanta Fed model's initial projection of Q122 Real GDP Growth is +0.1% (q/q, saar).

A slowdown in Q122 Real GDP Growth would be in line with Fed Chair Powell's expectation of a virus-related drag on economic activity at the start of the year.  He expects any slowdown to be followed by a resurgence of growth in Q222.  The high 0.7% m/m jump in Average Hourly Earnings, however, underscores why the Fed will have to act against a pickup in growth, possibly aggressively at some point, in order to create more labor market slack.  

High wage inflation does not mean that price inflation cannot be held down by temporary factors.  And, that may be the case with the January CPI.  In particular, covid-induced pullbacks in travel and eating out may have prompted airlines to cut airfares and restaurants to hold prices steady.  This could keep the January CPI below the consensus estimate of +0.5% m/m for both Total and Core.