Caution Ahead of Key US Economic Data and Govt Shutdown?

The stock market may continue to trade cautiously this week as the federal government risks a shutdown and key US economic data are not expected to change the overall picture.  However, there is reason to think these factors may be taken in stride.  Both the September Mfg ISM and Nonfarm Payrolls are seen improving somewhat from their August prints.  However, their improvement is expected to be modest and should not change the markets' probabilities of further Fed easing.  A more positive market tone could reemerge afterwards as Q325 corporate earnings are released.

Consensus looks for Nonfarm Payrolls to rise by only 39k m/m, versus +22k in August.  However, the latest Unemployment Claims data suggest the risk is for a somewhat larger increase.  Consensus estimates for the other important parts of the Employment Report are more of the same: a steady 4.3% Unemployment Rate and 34.2 Nonfarm Workweek, and 0.3% m/m Average Hourly Earnings.  Rounding analysis suggests a better chance of a 3.4% than 3.2% Rate.  The unrounded Unemployment Rate was 4.32% in August.  Consensus prints shouldn't change the Fed's view of the outlook -- still cautious but not overly concerned about the economic outlook.

Consensus looks for the September Mfg ISM to edge up to 49.2 from 48.7.   This would remain at a level suggesting modest economic growth.   It would be a bit below the 49.4 H125 average.  Real GDP Growth averaged 1.6% (annualized) in H125.

The stock market has not liked government shutdowns in the past.  However, it may be different this time for two reasons.  The long end of the Treasury market appears to be sensitive to large shifts in the 10-year projection of the Federal Deficit, as seen in a rise in yields when the courts threatened an end of Trump's tariffs.  The government revenue impact became more important as the inflationary impact has so far been modest.  The markets may view a shutdown as a way that Trump will cut government spending.  And, it would prevent the renewal of some government subsidies being pushed by Democrats.   

Consensus looks for about 7.5% (y/y) growth in Q325 corporate earnings.  This is below the 12.0% seen in Q225.  However, it is still strong.   And the consensus estimate tends to be too low, so a stronger quarter is conceivable.  The macro evidence supports this risk.  Real GDP Growth sped up on a y/y basis,  based on the Atlanta Fed model's estimate for Q325.  The dollar weakened as economic activity abroad improved.  Both boost earnings made abroad.  There is a possibility that domestic profit margins improved, as the Core CPI climbed by more than Average Hourly Earnings.  Although some of the strength in the CPI reflects tariffs, which don't lift profits themselves, they offer domestic producers room to increase profit margins.  Finally, there should be a smaller drag from oil companies. 

                                                                                                                                      Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)

 Q124            2.9                +14.0                  0.0                              4.3           3.8              46.4 

Q224            3.0                  +2.5                +3.0                              3.9           3.4               46.3 

 

Q324            2.7                  -6.0                 +2.5                              3.8           3.2               45.3     

 

Q424            2.5                   0.0                 +3.5                              4.1           3.4               45.4       

 

Q125            2.1                  -6.5                +6.0                               3.9           3.1               47.6                                       

Q225            2.0                -16.0                +3.5                               3.9           2.8               49.3     

 

Q325            2.2                -11.0                -1.5                                3.8           3.1               50.0                 

                                                                           

* Based on the Atlanta Fed Model's latest projection of 3.9% for Q325 (q/q, saar).

 

A Growth-Friendly Fed

The stock market should continue to be buoyed by a growth-friendly Fed.  The 25 BP rate cut shows the Fed will respond to economic weakness.  And, the "dot" plot indicated a leaning toward further easing by most members of the FOMC meeting.  Fed Chair Powell and other Fed officials will likely reiterate the Fed's new emphasis on the downside risks to the economic outlook in speeches this week.

Soft US economic data, in real terms or inflation, should support expectations of further Fed easing and thus be positive for the stock market.  And, most of this week's US economic data are expected to be on the soft side.  Consensus looks for August Durable Goods Orders to dip, both in Total and Ex Transportation.  It also expects declines in August New and Existing Home Sales and a rebound in Initial Unemployment Claims.  The August PCE Deflator is seen up a modest 0.2% m/m for Core.  However, August Consumption is expected to rise 0.5% m/m -- a  decent gain even after adjusting for inflation.

The Fed expects modest economic growth and a temporarily higher pace of inflation into early next year, according to Fed Chair Powell at his post-meeting news conference.  The 1.4-1.7% Central Tendency Forecast for 2025 (Q4/Q4) implies 1.4-2.0% Real GDP Growth for the second half of the year, given the 1.4% growth in the first half.  If the Atlanta Fed Model's estimate of 3.3% for Q325 Real GDP and the Central Tendency forecast are right, then Real GDP has to weaken t o -0.5% to +0.7% (q/q, saar) in Q425. Except for a possible recession in Q425 in this scenario, the annual Central Tendency forecast is at or slightly below the Fed's estimate of longer-run growth.

Such a growth pace would likely be acceptable for the stock market inasmuch as labor costs should remain contained.  Powell acknowledged that wage inflation has moderated and that both labor demand and supply have fallen.  Although the pass-through of tariffs has been slower and smaller than the Fed expected, it still sees the tariffs to be more fully passed through over time -- a positive for the path of corporate earnings.  Specifically,  the Fed looks for the tariffs' boost to prices to grow through the rest of the year and possibly into 2026.  

The future path of monetary policy will depend on economic developments ahead, but the likely direction is for lower rates.  Although there was only one vote for a 50 BP rate cut at last week's FOMC Meeting, nine of 19 participants look for 2 or more 25 BP cuts this year.  There are reasons to expect a persistence of the current combination of modest growth and moderate inflation for the rest of the year, supporting more rate cuts.  The slowdown in immigration has been a major factor holding back labor force growth (and a negative for demand for goods and services).  This restraint is not going away.  And, besides modest wage inflation, most measures of longer-term inflation expectations continue to be consistent with the Fed's projections, according to Powell.   This is not the case, however, with the University of Michigan Survey's 5-Year Inflation Expectations figure, which, at 3.9% in mid August, is well above its 3.0-3.2% pre-tariff range.  The final print for the month will be released this week.

A rising stock market would be desirable for the Fed, since it is a major channel (via consumption) through which easier monetary policy supports the economy.  Lower short-term rates also help through the reduction in borrowing costs on credit cards and auto loans.  However, the channel through lower longer-term yields may be hampered in the near term by their being lifted by the variability of short-term rates and the dollar.  They raise the risk premium in the term structure of interest rates.

 

 

 

 

A 25 BP Fed Rate Cut, More To Come?

The stock market rally should be sustained by this week's FOMC Meeting.  Besides a 25 BP rate cut, the Statement or, more likely, Fed Chair Powell could signal that more easing will be coming if needed.  And, this week's US economic data are expected to keep that possibility alive by underscoring a sluggish growth pace.

A Fed easing path will likely embody a number of 25 BP rate cuts.  There are several reasons to expect such a cautious path.  First, inflation remains higher than target, with the culprits including more than just tariffs.  In particular, housing rent (primary and owners' equivalent rent) continue to run 0.3-0.4% m/m.  It likely needs to slow to 0.2% in order for the Fed to hit its 2% inflation target.

And, tariffs remain a problem for the inflation fight, although there were some signs of a moderation in their impact in the August CPI.  A jump in Food Prices At Home in August may have been caused in part by tariffs.  The unusually large 0.6% in these prices most certainly is a factor behind the depressed level of consumer confidence.  In contrast, Household Furnishings and Recreational Commodities flattened out after a couple of months of large increases, suggesting the impact of tariffs on them is settling down, in line with the Fed's best guess that the tariffs will have a one-off impact on inflation. 

Nevertheless, the Fed may be concerned by signs that longer-run inflation expectations have ratcheted up.  The University of Michigan Consumer Sentiment Survey shows 5-year inflation expectations at 3.9%, well above the 3.0-3.2% range seen before the start of tariffs.  

As a result, allowing a somewhat softer labor market for a while may be optimal monetary policy in the context of tariffs.  It would prevent a wage-price spiral from developing by dissuading labor from bargaining for higher wages to offset the loss of purchasing power.  The Fed would never admit to this reason.  However, Powell acknowledges that wage inflation has not been a source of inflationary pressure, showing that Fed officials are cognizant of this potential.

A sluggish pace of economic growth is expected to be apparent in this week's US economic data releases.  Consensus looks for a slowdown in Retail Sales to 0.3% m/m in August from 0.5% in July.  Ex Auto Sales are seen repeating July's modest 0.3% increase.  This gain is even smaller in real terms, that is once inflation is taken into account.  Consensus sees flat August Industrial Production after -0.1% in July.  There is downside risk from a likely decline in Manufacturing Output after a flat July.   Consensus expects little m/m change in August Housing Starts and Permits.

 

  

Green Light For A Fed Rate Cut

The stock market should continue to climb this week, anticipating a Fed rate cut at the September 16-17 FOMC Meeting.  After the soft August Employment Report, this week's release of the August CPI should not derail the expected decision.  A rate cut, even a modest 25 BPs, would signal that the Fed will act to combat economic weakness ahead -- making the possibility of future economic weakness less problematic for stocks.

The consensus estimate of 0.3% m/m for Total and Core CPI looks reasonable, as the tariff impact should still be noticeable -- which the Fed could view as unavoidable but temporary.  A lower Core is not out of the question, nonetheless, but probably requiring a slowdown in Owners' Equivalent Rent to 0.2% from 0.3%.  Consensus has the Core's y/y steady at 3.1%.  However, a rounded-up 0.3% print could result in a dip in the y/y to 3.0%.  The markets may pay attention if this happens.

The August Employment Report already gave the Fed the excuse it needed to cut rates at the September 16-17 FOMC Meeting.  Besides soft job growth and an uptick in the Unemployment Rate, Total Hours Worked are down q/q in Q325.

The +22k m/m increase in Nonfarm Payrolls was the 4h month in a row of only a double-digit gain.  It was well below the 125k m/m increase consistent with a steady Unemployment Rate (and steady labor force participation rate).  The Diffusion Index (percentage of industries with job gains) stayed below 50%: 49.6% versus 48% in July).  There were declines in cyclical sectors, like Construction and Manufacturing, but also in Professional and Business Services (some of which conceivably could be tied to AI).

The uptick in the Unemployment Rate to 4.3% from 4.2% can be attributed to an increase in the Labor Force Participation Rate.  However, there were some troubling signs from the Household Survey.  The politically sensitive Black Unemployment Rate continued to climb, rising to 7.5% from  7.1% (mostly women).   And the Duration of Unemployment rose for the second month in a row.  The broadest measure of Underutilized Labor Force, U-6, rose to 8.1% from 7.9%.  This is its highest level since October 2021.

Average Hourly Earnings remained at trend, rising 0.3% m/m.  However, only 7 of 13 sectors had changes of 0.3% or less, compared to 11 of 13 in the Q225 average.  So, while the wage data have good news overall for the inflation outlook, there is not yet an all-clear.  Nevertheless, it should have assuaged some Fed concern about the potential for a wage-price spiral emanating from the tariffs.

With the Nonfarm Workweek unchanged from a downward-revised 34.2 Hours in July, Total Hours Worked were flat in August and are 0.5% (annualized) below the Q225 average.  As a result, the Atlanta Fed model's 3.0% estimate for Q325 Real GDP Growth continues to look too high.  However, if it is correct, it would be because of strong productivity growth -- a positive for Q325 corporate earnings and stocks.