The stock market's rally may be slowed by August's seasonal weakness, but it should not be derailed. The supportive macroeconomic themes of moderate growth and inflation should persist. Further ahead, stocks could face a problem if growth and inflation do not abate and the Fed becomes more aggressive in tightening. With this in mind, there are some upside risks to the key data released in August. Their implications for Fed policy, however, will be mitigated by the fact that another set of key data will be released before the next FOMC Meeting in September.
At this point, it seems likely that the funds rate will be hiked another 25 BPs at the September 19-20 FOMC Meeting. Economic growth doesn't appear to be slowing. And, a hike would be consistent with the Fed's Central Tendency forecast. For both reasons, the market could take the hike in stride. What could be a more significant negative for the market would be if the Fed raises its endpoint of tightening. And, unless July-August inflation data slow further, this is a good possibility. At his post-FOMC news conference last week, Powell opened the door for a string of rate hikes ahead.
Powell essentially said the Fed will keep tightening until it becomes clear that inflation will settle down at 2% for an extended period. When this will happen is not known. He said that while monetary policy tightening may stop before 2% inflation is achieved, Fed officials will need to have a good sense that this goal will be realized soon thereafter. He was not specific about which data points would be persuasive, but presumably a softening in labor market conditions is one of them. The latest Unemployment Claims data don't suggest this is happening now.
Powell mentioned one factor that presumably makes officials comfortable with their gradual pace of tightening -- the real funds rate is above its historical average. He didn't say this, but there are reasons why a high real funds rate is now appropriate and should not be reversed soon. Defense restocking, shifting production back to the US from abroad, and rebuilding the US energy system are providing thrusts to economic activity. A high real funds rate is needed to crowd out other economic activities, given how tight the labor market is, if these developments are not to further ignite inflation.
Failure to accomplish a significant enough amount of crowding out may be the most important downside risk to the stock market. Fed officials could become frustrated with their gradual 25 BP tightening approach and opt for a larger hike at some meeting -- similar to what happened in 1994.
Consensus estimates of this week's key US data do not suggest these macroeconomic issues will be resolved soon. Labor market data are expected to show continued above-trend job growth with little, if any, easing in labor market tightness. Payrolls are seen up 200k m/m, about the same as in June (+209k), with the Unemployment Rate steady at 3.6%. Job Openings are estimated to fall to 9.62 Mn in June from 9.82 Mn in July -- in the desired direction, but still well above the 7.5 Mn pre-pandemic trend. Average Hourly Earnings are seen at 0.3% m/m, welcome after printing 0.4% in the prior two months but one month does not make a trend.
Note that the Claims and other evidence don't rule out a speedup in Payrolls. Consensus expects Private Payrolls to speed up, but to be offset by a decline in Government Jobs after the latter jumped in June. Timing or seasonal adjustment issues may have caused the jump and could reverse in July. Strikers will subtract only a minor amount this month.
Consensus estimates of the Mfg and Non-Mfg ISMs are mixed. The Mfg ISM is seen edging up to 46.8 in July from 46.0 in June -- a somewhat better level but still in recession territory. The Non-Mfg ISM is seen slipping to 53.0 from 53.9.
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