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.