Stocks in Trouble After Powell's Speech, But...

The stock market is in trouble after Powell's hawkish speech at Jackson Hole, particularly in this seasonally weak period.  His comments suggest that Fed tightening won't stop until the Unemployment Rate climbs and Wage Inflation falls.  The market faces the prospect of either a recession or much higher rates.  But, there is a caveat.  Stocks could stabilize if wage inflation slows without a sharp weakening in the economy.

Powell emphasized three developments that are needed to bring down inflation: /1/ A softening in labor market conditions, /2/ below-trend GDP growth, and /3/ low and stable longer-run inflation expectations.  Recent evidence is favorable in terms of the second two developments.  But, not the first.  So, at this point, a 75 BP rate hike at the September 20-21 FOMC Meeting is in play.

Regarding recent evidence:

1. The Atlanta Fed model's 1.6% early estimate is below the 1.8-2.0% long-run trend estimated by the Fed -- a positive from the Fed's perspective, but arguable not low enough.

2. The 2.9% 5-Year Inflation Expectations in the Final-August University of Michigan Consumer Sentiment Survey keeps this measure within its recent range --  a positive from the Fed's perspective.

3.  But, the Claims data have begun to suggest that the recent softening in labor market conditions may be ending.  If Claims continue to be steady or lower, they will reinforce the Fed's view that the labor market is solid and too tight. 

Consensus estimates of this week's key US economic data are not expected to be particularly soft.  If so, they should keep open the door for a 75 BP hike.  Consensus looks for a 0.7 pt dip in the August Mfg ISM to 52.0, pointing to decent growth in the manufacturing sector.  It has to fall below 48.7 to signal contraction.  The fundamentals behind this sector are mixed.  The strong dollar and weaker growth abroad should weigh on exports.  But, the motor vehicle sector seems to be getting out of the chip shortage situation, as assemblies rose in July.  

Consensus expects a moderately strong August Employment Report.  Nonfarm Payrolls are seen slowing to +285k m/m from the huge +528k in July.   But, Payrolls need to rise by less than 100k m/m to be consistent with an increase in the Unemployment Rate.  So, it is not surprising that consensus looks for a steady 3.5% Unemployment Rate.  Moreover, consensus sees Average Hourly Earnings (AHE) rising 0.4% m/m, down from 0.5% in July and in line with the trend in H122.  But, AHE needs to slow to 0.3% or lower to be consistent with the Fed's 2% price inflation target.  

A low AHE print would be a positive market surprise.  And, there is a possibility that wage inflation will slow without a sharp rise in the Unemployment Rate.  There are several reasons.  /1/ The relationship between the level of the Unemployment Rate and Wage Inflation has become tenuous over the past 20-30 years.  Globalization of the labor force may have been the cause, as US workers knew they would risk losing their jobs to imports if wages were hiked too much.  If this factor is still important, the recently strong dollar and surge in immigrants could hold down wage inflation independently of the Unemployment Rate.  /2/  The recent flattening in the Unemployment Rate and decline in commodity prices could slow wage inflation.  The standard Wage Equation has the Change in the Unemployment Rate (as well as its level) and lagged inflation as significant determinants of wage inflation.