A Relief Rally?

A relief rally by the stock market probably will require two developments: /1/ a November CPI near consensus and /2/ less-than-feared rate projections coming out of the December 13-14 FOMC Meeting.  If the markets get past these two events unscathed, then a window opens for a "Santa Claus" rally into year end if not longer.

Consensus looks for +0.3% m/m Total and Core CPI for November.  This expectation can't be dismissed, but there may be more upside than downside risk.  A consensus print would probably require /1/ Owners' Equivalent Rent coming in at +0.6% m/m, the same as in October, /2/ holiday discounting showing up in Apparel and other goods, and /3/ a further decline in Airfares.  Airline fares fell a large 5.0% m/m in the November PPI, but they are measured differently in the CPI.  Also, the decline in PPI Airfares could  be catch-up to the decline in CPI Airfares that occurred in October.

A downshift in Fed rate hikes to 50 BPs at this meeting is almost guaranteed.  This would raise the funds rate target to 4.25-4.5%.  The markets will likely focus on the endpoint projected for the funds rate in the "dot" chart and Central Tendency forecasts.  Endpoints of 5.0-7.0% have been mentioned by a few Fed officials in recent weeks.  An endpoint in the 5.5-6.0% range, implying 2-3 more 50 BP hikes, would probably be viewed favorably by the stock market.  The endpoint in the September Central Tendencies is 4.5-5.0%.

While news analyses focus on the risk of recession in analyzing the latest decline in the stock market, there is no sign as yet that one is imminent.  The Atlanta Fed model's forecast is back up to over 3.0% (q/q, saar) in Q422.  The labor market is slowing gradually, but it may be reflecting efficiency drives by companies rather than a weakening in demand for goods and services.

A continuation of solid economic growth can be attributed to several factors.  Fiscal policy is a positive.  In October, some state governments issued a large amount of tax rebates.  While they are one-time, they likely are helping to lift holiday spending.  Similarly, the stimulus-driven excess saving during the pandemic continues to be source of consumer purchasing power.  Defense restocking of armaments also may be helping some industries, as may be new incentives for investment in climate/energy projects.  Away from fiscal policy, the return of manufacturing activity from abroad is a positive, particularly if it entails large amounts of investment.

These factors are working against the Fed's goals of slowing the economy and pushing down inflation, raising the possibility that this week's endpoint forecasts may not be the last word on the subject.  But, there is time for the Fed to evaluate whether a further upward adjustment will be needed.  And, there are no signs yet of impending recession.  So, the markets might have a window in Q123 to worry less about Fed policy or an economic downturn.