The stock market may continue trying to regain the ground lost after Fed Chair Powell pulled back the likelihood of near-term rate cuts, helped by strong corporate earnings. However, the market risks facing an unfriendly FOMC Meeting (although with the possibility of one saving grace) and troublesome labor cost data this week.
The Fed is not likely to change its new, somewhat hawkish stance at this week's FOMC Meeting, despite the ironically soft 1.6% Q124 Real GDP print. Even though the low print is in line with the initial Fed projections for 2024 -- making their upward revision look foolish -- the slow growth did not prevent inflation from speeding up last quarter. Together, the slow growth and high inflation should keep Fed policy steady, probably through the elections. Powell should reiterate that the Fed wants to see more months of evidence to determine whether inflation is on a downtrend. To be sure, all this should be old news. The market may like his comments if, as is likely, he leaves the possibility of rate cuts at some point on the table.
This week's evidence on labor costs risks being unfriendly for the Fed. All three of the major measures -- Average Hourly Earnings, Employment Cost Index and Compensation/Hour -- will be released and may exceed consensus in some cases.
Consensus looks for the Q124 Employment Cost Index (ECI) to speed up to 1.0% (q/q) from 0.9% in Q423. Supporting this estimate, a curious inverse relationship with Average Hourly Earnings (AHE) in the past couple of years suggests ECI could match or exceed the Q423 pace -- when AHE slowed, ECI sped up and vice versa (see table below). It is not clear why this inverse relationship holds, but it represents an upside risk. ECI includes forms or compensation that AHE does not, such as bonus payments and health insurance premiums paid by employers. These could boost the ECI in Q1 of a year.
Consensus also looks for +0.3% m/m in April AHE. This would be a favorable print. However, last year, AHE sped up in April after low prints in February and March (as was the case this year too). So, there is upside risk to the consensus estimate, too.
Consensus expects 4.0% (q/q, saar) for Q124 Compensation/Hour. The risk is for a print closer to 5.0%, based on Personal Income and THW data. The market and Fed may take a cautious view of a high print, however, since Compensation/Hour tends to be volatile on a quarterly basis. Last year, it varied between 3.6% and 6.5% among the four quarters, averaging 5.2%.
(q/q percent change)
AHE ECI
Q124 0.97 na
Q423 1.02 0.9
Q323 0.8 1.1
Q223 1.2 1.0
Q123 0.8 1.2
Q422 1.2 1.1
Q322 1.1 1.2
The low 1.6% Q124 Real GDP pace is not entirely surprising, despite the 2+% estimates of the Atlanta Fed model and consensus estimates. The fact that the Unemployment Rate rose in Q124 (to 3.8% from 3.7%) hinted at a below-trend pace of Real GDP. Traditional models relate the direction of change in the Unemployment Rate inversely to GDP Growth less trend. Also, the fact that Total Hours Worked rose about 1.0% (q/q, saar) means that Productivity likely rose only slightly in the quarter (below the 2.0% consensus estimate). Conceivably, bad winter weather may have been partly responsible for holding down output per worker and thus the low GDP pace. The shift in jobs to low-productivity health care and government didn't help either.
There already were signs of a post-winter speedup in economic activity in March, particularly the rebound in the Nonfarm Workweek and Total Hours Worked (THW). THW in March were 2.0% (annualized) above the Q124 average, a strong take-off point. However, this week's April Employment Report is expected to show that this bounce-back is moderating. Consensus looks for a slowdown in Nonfarm Payrolls to +210k m/m from +303k in March. The estimate is lower than the +276k m/m Q124 average. A steady 34.4 Hour Nonfarm Workweek and 3.7% Unemployment Rate, as consensus expects, also would argue for a moderation in a post-winter bounce-back. Market friendly prints for Payrolls, Unemployment Rate and Workweek could outweigh a small speedup in AHE.
Hey! I appreciate you putting all of this together in a clear and concise manner.
ReplyDeleteAs the market's view have shifted, and currently does not expect any rate cuts this year, rates will remain higher for longer. Given the trend of over the past 12 months during which the Non-farm payroll has continuously been revised down, I can see a scenario of the market not fully trusting the data this week, and therefore, we might see counter-intuitive responses in the markets.
My biggest concern is the debt crisis that the US and Japan is facing. Combine this with the FED struggling to get inflation under control, a response of hiking rates, as suggested by Jamie Dimon, seems to be a possible short-term solution for the US to get inflation under control., but it will hurt other world economies.
We see the Yen being historically the weakest it has every been compared to the us dollar, and Bank of Japan struggle to keep it below the 150 mark. BOJ already hiked rates, but that had no effect on the trend of the yen. And it looks like BOJ tried to intervene at the Euro open today (lets see what happens). If we continue this trend, Japan will have to allocate a majority of their budget towards paying off debt. And with a decreasing population and expensive social programs, something has to be done.
My question to you is, where do you see the US economy in 2025? I have a difficult time justifying the current environment will lead to any type of soft landing. My current beliefs is that debt crisis around the world is very likely, money will rapidly flow out of equities, and we can see a severe recession, especially for the lower/middle class. The debt burden of the major economies governments will make it difficult to apply any QE over the coming 1-5 years. And on top of all of this, we have severe geopolitical risks.
1. Re Fed, if inflation does not trend down in 2024, I think the Fed will have a freer hand to tighten further after the Nov elections -- particularly if Biden is elected. This could precipitate a hard landing. If Trump is elected and Republicans control both Houses, the Fed might let concern over its independence restrain its monetary policy from tightening. News stories say Trump wants to control the Fed. I think it is possible for the CPI/PCE Deflator to slow in coming months as I mentioned in a prior blog.
Delete2. I think the huge Federal deficits and resulting issuance of debt would be a problem for equities if foreigners balk in holding the debt. The resulting drop in the dollar would boost longer-term Treasury yields and hurt stocks. The geopolitical risks so far support foreigners' holding of Treasuries and the dollar.
3. A continuation in US fiscal thrust, however, would need to crowd out other spending, given that the US economy is essentially at full employment. So far, the markets appear to be working in this direction through higher yields and stronger dollar as well as flattening equities. This situation could continue into next year unless the crowding out results in slower US economic growth over the remainder of this year.