Door Still Open For Fed Rate Cuts

The stock market should move up this week, after it was dented last week by concern the economy won't be soft enough to persuade the Fed to cut rates this year.  The most important report, the December Employment Report, was indeed strong.  It showed the economy needing to slow further to satisfy the Fed.  But, it did not shut the door on Fed rate cuts in 2024, since it still hinted that a slowdown was in progress.  This week's US economic data could keep the door open and help stocks recover, as they are expected to show benign inflation.

Two of the Employment Report's components suggest a slowdown in progress:

1.  The decline in the Nonfarm Workweek to 34.3 hours from 34.4 pushed down Total Hours Worked (THW) to -0.2% m/m in December.  The December level of THW is flat relative to the Q423 average -- a soft take-off point for Q124.  Moreover, THW slowed to +0.8% (q/q, saar) in Q423 from +1.3% in Q323.

2.  The drops in Civilian Employment and Labor Force likely reflect the small sample bias of the Household Survey.  So, not much should be made of them, even though they more than unwound their November jumps.  However, they raise the possibility of a smaller increase in January Nonfarm Payrolls, as Civilian Employment has some leading relationship to Payrolls.

It's noteworthy that more than half of the +216k Payroll gain in December was in Health Care, Social Assistance and Government.  Excluding these sectors, Payrolls rose 105k in December, after being essentially flat in October and November (excluding the impact of strikers).  Net Returning Strikers added about 8k  to December Payrolls.  These sectors are presumably little affected by Fed tightening or a slowdown in economic growth.  Nevertheless, their job gains exert pressure on the labor market.  So, their job growth has to be offset by weakness in other sectors to achieve the Fed's desired increase in the Unemployment Rate to 4.0+%.   

December's  0.4% m/m increase in Average Hourly Earnings (AHE), the second in a row, shows that the labor market is too tight.  AHE rose at least 0.4% in a majority of sectors both for December and on average over the last three months.  AHE needs to rise by 0.3% or less to be consistent with the Fed's 2% price inflation target, taking account of productivity.

A factor that could reduce the need to slow the economy sharply is if inflation moves down toward the Fed's target of 2% for non-macroeconomic reasons.  Fed officials have cited the resolution of pandemic-related shortages and supply disruptions as one such reason.  Lower import prices stemming from the stronger dollar and economic weakness abroad are another.  A factor yet to be fully seen would be a slowdown in housing rent as the CPI survey catches up to the softening seen in private surveys. 

Consensus looks for +0.2% m/m in both Total and Core CPI for December.  This estimate looks reasonable even if housing rent does not slow from its recent trend of 0.5%, but it probably requires that the price declines seen in other CPI components in November continue in December.  This is conceivable.  The unwinding of pandemic-related problems and lower import prices could have underpinned November price declines.  And, they could have continued to exert downward pressure in the rest of the holiday season.  Although the y/y for Total CPI is expected to edge up, the y/y for the more important Core CPI is seen falling to 3.8% from 4.0%.