The stock market is likely to enter the week with positive expectations of a downshift in Fed rate hikes at the FOMC Meeting and softer key US economic data. But, the FOMC Meeting and key US economic data may not resolve the issue regarding the endpoint of Fed tightening, a continuation of which could temper the market rally. Although the Fed is likely to downshift to a 25 BP rate hike at the Meeting, it should keep open the door for additional hikes ahead. This possibility risks being underscored by above-consensus prints for the January Mfg ISM and Payrolls.
The market will probably view Tuesday's Q422 Employment Cost Index (ECI) as an important input into the Fed deliberations, since Fed Vice Chair Brainard highlighted it in her speech. But, its importance may be exaggerated for reasons discussed below. Consensus expects the ECI to slow to 1.1% from 1.2%. A slowdown in the ECI, though, is not a slam-dunk, as the evidence is mixed. Lower sales commissions, resulting from fewer autos and homes sold, may hold down the ECI. But, Average Hourly Earnings (AHE) did not slow in Q422, when measured over the 3 months of the quarter (which is how the ECI is measured). Both moved in the same direction in each of the prior 3 quarters (see table below). And, even if the consensus estimate prints, the y/y would rise.
AHE and ECI do not measure labor costs the same way. ECI looks at wage and benefits for specific occupations and is not affected by compositional shifts among them, unlike AHE. But, as I have argued, a compositional shift toward lower-paid workers, -- either by substituting new, younger workers for retiring older workers or by reducing overtime through hiring additional workers -- can play a role in reducing price inflation. So, the ECI may not tell the whole story regarding labor costs and price inflation. It's unlikely that an above-consensus print for the Q2ECI will prevent the Fed from downshifting.
Although not typically getting much market attention, the Productivity/Unit Labor Cost Report for Q422 is expected to have good news regarding the inflation outlook. Nonfarm Productivity is seen rising an above-trend 2.4% (q/q, saar) and Unit Labor Costs (ULC) rising 1.5%. ULC incorporates the broadest measure of labor costs, Compensation/Hour. The consensus estimates imply 3.9% for it. This would be a speedup from 3.2% in Q222, but would put the Q4/Q4 increase at 2.9%, versus 5.2% in 2021.
Consensus could be underestimating other data due this week, as well. Consensus looks for another dip in the January Mfg ISM. But, a number of other manufacturing surveys suggest an uptick. Consensus expects a slowdown in January Payrolls to +185k m/m from +223k in December. But, the Claims and other evidence suggest a speedup. For one, seasonal factors could overly boost jobs in Retail, Couriers and Temporary Help, to the extent the seasonals overly depressed them in November or December. In this case, the market could discount a strong Payroll print as being one-off.
Other parts of the January Employment Report could move in a Fed-friendly way. Consensus sees the January Unemployment Rate moving back to 3.6% after it unexpectedly dipped to 3.5% in December. The Claims data suggest upside risk to consensus. Consensus also sees a modest 0.3% m/m increase in Average Hourly Earnings, an increase that would be consistent with 2% (annualized) price inflation after taking account of trend productivity growth. Away from the Employment Report, consensus sees a 300k decline in December Job Openings to 10.2 Mn. This would be in the "right" direction, but still well above the pre-pandemic 7.0 Mn level. So, it would not close the door on more rate hikes ahead.
Table
Average Hourly Earnings and Employment Cost Index
(Qtr-End to Qtr-End 3-Month Percent Change) y/y percent change
AHE ECI AHE ECI
Q122 1.2 1.4 5.6 4.5
Q2 1.1 1.3 5.2 5.1
Q3 1.0 1.2 5.1 5.0
Q4 1.0 1.1 (e) 4.6 5.2 (e)
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