Stocks OK Into Next FOMC Meeting, But Then?

The stock market should continue to climb this week, helped by corporate earnings and benign inflation data.  So far, more than 2/3 of Q423 earnings reports have exceeded estimates.  And, while not all of last week's US economic data slowed relative to their Q323 pace, many did and, importantly, inflation expectations fell.  All told, the door is not shut for Fed rate cuts at some point this year, and this expectations should underpin the market rally into next week's FOMC Meeting.  After the Meeting, the markets still will have to be concerned if economic growth or inflation are too strong.  The January Employment Report could be the next test.

The upshot of the latest round of US economic data shows a still resilient consumer and a modest upturn in residential construction but soft manufacturing outside of motor vehicles and high tech.  Overall, the labor market has resumed tightening, according to the Unemployment Claims data.  And, if the Claims data stay at their latest levels in this week's report, they would point to a speedup in January Nonfarm Payrolls (due February 2).  The Atlanta Fed model's latest Real GDP projection (2.4% q/q, saar) indicates that economic growth was slightly above trend in Q423.  

Real GDP Growth presumably needs to slow further this year if the Fed is to cut rates, unless inflation falls despite solid growth.  The Fed can be patient without shutting the door on cuts, which might be Fed Chair Powell's message next week.  One Fed official said he looks for rate cuts to begin in Q324.  Being patient means the Fed can downplay high prints for January inflation data, saying they reflect start-of-year hikes that won't persist.  For example, pharmaceutical companies are reported to be hiking a number of drug prices this month, which could show up in the CPI.  This week's inflation data -- the PCE Deflator -- are for December.  Consensus looks for a benign 0.2% m/m for both Total and Core.  This would be lower than the CPI's 0.3% prints and be in line with the Fed's 2% target.

Even with a patient Fed, the markets will likely respond negatively if upcoming data don't point to slower, non-inflationary growth.  With the Fed on hold, work to slow the economy will fall on the markets.  So, they may not be happy with a strong January Employment Report, particularly if it shows a persistently large increase in Average Hourly Earnings.