Stocks Not Out of Woods Re Fed

The stock market is not out of the woods with regard to the Fed after last week's key events.  The September FOMC Minutes and Fed Vice Chair Brainard's speech underscored officials' intent to bring down inflation, but they appear to plan sticking with the measured pace of tightening seen in the Fed's Central Tendency forecasts.  The high September CPI should not derail their adherence to this plan at the November 1-2 FOMC Meeting.  But, a slowdown in underlying inflation by early next year could be critical to their continued adherence.

The high 0.6% m/m September Core CPI underscored the stickiness of underlying inflation.  While the largest component, Shelter (includes Owner's Equivalent Rent) is largely backward looking and still moving up as a result of past increases, the Core Excluding Shelter rose +0.5% m/m in each of the past two months.  Although this pace is slightly less than the 0.6% m/m average over H122, it needs to slow to 0.2% or lower to get to the Fed's 2% target.

The real-side of the economy may not be slowing enough to knock down inflation. Ex Auto/Ex Gasoline Retail Sales slowed to +0.3% m/m in September from +0.6% in August.  The slowdown could be just the typical follow-through after a strong month, however.  The Atlanta Fed model's estimate of Q322 Real GDP only edged down to 2.8% (q/q, saar) from 2.9% as a result of the Retail Sales data.  Regarding the labor market, Initial Unemployment Insurance Claims have moved up a bit so far in October, but they remain below August levels.  Demand for labor remains strong.

One favorable feature of the current economic situation is that longer-term inflation expectations have been well contained -- which should mollify Fed officials to some extent and argue against the need to tighten more aggressively than what is embodied in the Central Tendencies.  The University of Michigan Consumer Sentiment Survey's 5-year inflation expectations rebounded to 2.9% in Mid-October from a low 2.7% in September.  The level is still low.  It has been in a 2.7-2.9% range since July, after a 3.0-3.1% range in H122. 

Fed Vice Chair Brainard, in her speech, acknowledged the contained longer-run inflation expectations.  And, she pointed out some evidence suggesting a re-balancing of the labor market.  Regarding monetary policy, she said it will take time for the cumulative effect of higher rates to bring inflation down.  This view suggests the Fed will not be derailed from its deliberate path of tightening because of currently high inflation prints. But, at some point, a continuation of high inflation data could prompt a more aggressive tightening path than now penciled in. 

She ended her speech with, "In light of elevated global economic and financial uncertainty, moving forward deliberately and in a data-dependent manner will enable us to learn how economic activity, employment, and inflation are adjusting to cumulative tightening in order to inform our assessments of the path of the policy rate."  The issue will probably become more critical early next year, when there will have been more time to see the effects of the recent tightening.   A further slowdown in underlying inflation would need to be seen by then.