More Fed Downshifting?

Continuation of the stock market's rally may depend on /1/ economic data pointing to a further downshifting in Fed rate hikes from 50 BPs to 25 BPs and /2/ better-than-expected Q422 corporate earnings.  With these issues in mind, the market this week will face a speech by Fed Chair Powell (Tuesday), the December CPI (Thursday), and the start of earnings season.   

Powell is not likely to change the odds regarding a further downshifting in rate hikes.  He will probably reiterate the Fed's commitment to lower inflation and the data-dependency of policy.   At this point, not enough data has been released to be confident about the outcome of the next FOMC Meeting.  Some Fed officials have said they are open to either 25 or 50 BP hike, so a further downshifting is not out of the question even if Powell does not mention it in this week's speech.

The consensus estimate for the December CPI (0.0% m/m Total and +0.3% Core) is borderline with respect to Fed policy.  The risk is that the Total CPI will fall, based on the drop in gasoline prices.  But, this can be viewed as one-off.  Although a 0.3% Core lowers the y/y to 5.7% from 6.0%, it is a speedup from November's +0.2% and above the Fed's 2% (annualized) target.    Moreover, the risks are two-sided.  A lower-than-consensus Core can't be ruled out.  But, it may require a larger drop in Airfares than in November, a slowdown in Owner Occupied and Primary Rent, heavy holiday discounting, or a continuation of lower Medical Care Services Prices (reflecting health insurance measurement).  A rebound in the latter could push the Core CPI up to +0.4%.

The December Employment Report kept open the door for the Fed to downshift -- even though Payrolls were strong and the Unemployment Rate fell.  First, wage inflation may be slowing to a reasonable pace.  The +0.3% m/m in Average Hourly Earnings, after a downward-revised +0.4% in November, is in line with the Fed's 2% price inflation target, taking account of productivity growth.  Second, economic activity appears to be slowing.  Total Hours Worked (THW) dipped 0.1% m/m, keeping it in a flattish range since September.  The December level is 0.5% (annualized) below the Q422 average -- a weak take-off point for Q123.  For the quarter as a whole, THW rose 1.1% (q/q, saar) in Q422 versus +2.3% in Q322.  THW was particularly weak in the Nondurable Manufacturing Sector, pointing to another decline in Manufacturing Output in the December Industrial Production Report.

There is a way to reconcile the strong headline prints (Payrolls and Unemployment Rate) and the underlying softness of the data.  Companies may be hiring people to eliminate high-cost overtime among existing workers.  This could entail hiring part-timers, which, in fact, the data show happened in November and December.   In addition, a shift to part-timers or reduced hours for existing workers could reflect companies' cautious approach to a softening in demand for their products.  These shifts could explain the continuing large job gains and fall in unemployment, while reducing overall hours worked.  They also could help explain the slowdown in wage inflation.