A "Powell Put" Supports Stocks

The stock market should continue to climb this week, helped by economic data expected to show benign inflation and slower growth.  They would likely be viewed as keeping rate cuts on the table in the Fed's outlook.  Moreover, although the market was disappointed initially by Fed Chair Powell's dismissal of a rate cut at the March FOMC Meeting, his and other Fed officials' comments that rate cuts at some point are still possible constitute a strong pro-growth stance that supports stocks.

The Fed's view of rate cuts ahead can be viewed as a "Powell put" -- the Fed will ease if there are signs of weaker economic growth or inflation.  It tells the stock market to downplay signs of economic weakness, since the Fed will respond.  It essentially eliminates a negative "tail risk" regarding the economic outlook.

To be sure, the Fed's Central Tendency Forecast of rate cuts in 2024 appeared to be tied to projections of sub-2.0% Real GDP Growth, higher Unemployment Rate and lower inflation.   The first two projections so far are not working out.  The Atlanta Fed and NY Fed nowcast models project 3.0-4.0% Real GDP Growth in Q124, based on data released so far.  And, the Unemployment Rate was steady in January.  There is tentative evidence, however, that the economy's strength may soften in February.  Both Initial and Continuing Unemployment Claims are above their January averages in the latest week.

The Fed's dovish stance in the face of strong data raise questions about its motivation.  The Fed's explanation is that real interest rates will rise if nominal rates are steady and inflation expectations fall.  Higher real rates will slow the economy.  The problem with this explanation is that inflation expectations are not reliably measured.  A more reliable way on which to base policy would be to see if economic growth, in fact, slows.  This result is probably what will truly prompt the Fed to cut rates.  Powell and other Fed officials indirectly suggest this is the case when they say they are not yet convinced that their 2% inflation target is being met. 

Keeping rate cuts on the table may have a political motivation.  It could deflect Congressional criticism of high interest rates by showing the Fed will ease at some point.  Ironically, one reason for the strong economic growth is the fiscal thrust from increased government purchases, incentives and subsidies.  So, when Senator Warren criticizes the Fed for keeping rates too high, she is pointing her finger to the wrong group.  Indeed, with Biden economics pushing the economy's resources into particular areas, a continuation of high interest rates may be needed to "crowd out" others.  Nevertheless, if economic growth slows into the Spring, it could give the Fed a window to cut rates.  The timing presumably would be advantageous, being well ahead of the Presidential election.

Slow-to-cut or steady Fed policy may become less of a problem for the stock market over time if economic growth remains strong.  The market could realize that corporate earnings will stay healthy despite continuing tight Fed policy.  

The long-end of the Treasury market will tell whether a patient Fed is what's called for.  Longer-term Treasuries stand ready to act as vigilantes against inflationary tendencies in the economy if they surface and the Fed fails to respond.  Longer-term yields will fall if economic growth and inflation slow.

To be sure, Powell's downplaying of a growth/inflation trade-off argues for policy patience.  Strong growth may not result in higher inflation according to this view.  This week's consensus estimate of the January CPI  (Total +0;.2% m/m and Core +0.3%) would lend support to this view, as it will likely translate into lower prints for the PCE Deflator.  The consensus estimate looks reasonable, with mixed risks.  On the upside, there is a possibility that start-of-year price hikes could boost the CPI.   On the downside, seasonals could overly depress some prices if there had less-than-normal seasonal holiday discounting in November-December.  There could be a smaller-than-normal rebound in prices in January.

Besides a benign January CPI, consensus expects softer real-side economic data this week.  Retail Sales are seen slowing to +0.2% m/m in January from +0.6% in December.  Although consensus sees a speedup in Industrial Production to +0.4% m/m from +0.2% in December, there is downside risk given the decline in Total Hours Worked in manufacturing last month.