Year-End Rally?

The stock market may try to eke out a year-end Christmas rally in the next couple of weeks, as the macroeconomic background is not standing in the way.  Although some Fed officials and market analysts voiced concern about the accuracy of last week's key US economic data,  the latter do not shut the door on a January Fed rate cut even if somewhat distorted.  

The November Employment Report painted a picture of a sluggish labor market.  Private Payrolls sped up to only 69k m/m from +52k in October.  The latest 3-month average is 75k m/m, which may in fact be only +15k if the Fed is right that the m/m changes in Payrolls are now overstated by 60k.  With job growth so slow, it's not surprising that the Unemployment Rate has moved up noticeably.  These two parts of the Report confirm the Fed's concern of a weak labor market.  

That said, other parts of the Report argue against a weakening economy.  Although companies held back in expanding payrolls, they lengthened the hours worked by existing employees.  The Nonfarm Workweek edged up to 34.3 Hours from a low 34.2 Hour in the prior two months.  As a result, Total Hours Worked (THW)  in November are about 1.0% (annualized) above the Q325 average (taking account of the overstatement in Payrolls), compared to 0.0% (q/q, annualized) in Q225.  The improvement in THW so far in Q425 suggests a speedup in economic growth.  However, all that may be happening is a catch-up in this measure of labor to the strong GDP Growth in Q325 -- if the Atlanta  Fed Model's 3.5% estimate or the consensus estimate of 3.2% of the latter is correct (the actual will be released on Tuesday).  

A more interesting possibility is that AI and other capital investments are substituting for labor without hurting GDP Growth.  While some growth in THW through a longer workweek is needed to meet demand, Productivity Growth has ratcheted up.  If this is correct and sustaining, then the longer-run, non-inflationary trend in economic growth is significantly higher than the 1.8-2.0% Fed estimate.  In this case, the Fed should aim for stronger Real GDP Growth than what it has been doing.   It would call for easier monetary policy next year.  From a stock market perspective, it would be a positive for corporate earnings even if the Fed does not cut rates.

The low November CPI, at least on the surface, offered hope that inflation is moving down.  The y/y fell to 2.7% for Total and 2.6% for Core.  Some Fed officials and market economists raised questions about the ways some major components, such as Owners' Equivalent Rent (OER), were calculated, given the timing and sampling issues stemming from the government shutdown.   OER was estimated to rise by the same percentage change in October and November as the low print for September.  This may not be a bad estimate, however, despite the doubt expressed by some.  A sustained low rate of increase in OER would be consistent with the softening in rents seen by private surveys.  The accuracy issue with the CPI could be resolved with the back-to-normal December CPI Report, which should be released before the January FOMC Meeting.