Supreme Court Hurdles

The stock market may have to contend with important Supreme Court rulings on the Fed and tariffs this week.   On Tuesday, the Court may release its decision on whether Trump can fire Fed Governor Lisa Cook and whether Trump's tariffs are legal.  Possible market reactions are discussed below.  Favorable corporate earnings reports should cushion any market-unfavorable ruling.  

The stock market's reaction to a Court decision could depend on how the latter impacts longer-term Treasury yields.   A decision permitting Trump to fire Cook could be viewed as a step towards undermining Fed independence.  This would exacerbate future inflation risks, resulting in a steeper yield curve --which would be a negative for stocks.  To be sure, a replacement for Cook, along with a new Fed Chairman in May, would lift the probability of Fed rate cuts this Spring.   However, this possibility is likely too far ahead to provide a noticeable boost to stocks now.

In contrast, a Court ruling against Trump's authority to fire Cook could bolster the idea of Fed independence.  The yield curve should flatten, which would be a positive for stocks.  A decision that does not address Trump's authority to fire a Fed Governor but allows Cook to keep her job may have a minor impact on the stock market.  The question of Fed independence would just remain in the background and be ignored for now.  Such decision, however, could dampen the probability of a rate cut this Spring, making it more dependent on upcoming US economic data.

A Court decision permitting Trump's tariffs could be a positive for the stock market.  It would retain the government's collection of tariffs that have helped reduce the Federal Deficit, which is a positive for longer-term Treasuries and thus stocks.  The inflation boost from tariffs may be mostly behind us, so it could be a less important implication for the markets.  However, since it would leave open the door for Trump to impose more tariffs by whim, it would maintain a degree of uncertainty in the economic outlook that could hurt growth.  This impact would remain to be seen, so should not have an immediate effect on stocks.

A decision against Trump's tariffs could lift longer-term Treasury yields, a negative for stocks, because it would lift estimates of the Federal Budget Deficit.  However, since Trump has said there are other ways to maintain tariffs besides his declaration of a state of emergency, the markets' reaction may be muted.

Meanwhile, the macroeconomic background appears to be shifting against the need for a Fed rate cut.  Although the headline December CPI was benign, with Total +0.3% m/m and Core +0.2%, the composition did not show widespread softness.  There were a number of large increases, possibly related to tariffs or to lingering issues from the government shutdown's interference with the CPI survey.  The Fed will likely wait to see a sustained broader pattern of modest inflation before saying inflation is "licked."

The real-side of the economy appears to be doing well.  The Atlanta Fed Model's latest estimate of Q425 Real GDP Growth is 5.3% (q/q, saar) -- implying another quarter of strong productivity growth.  Manufacturing Output in the Industrial Production Report has picked up over the past two months from a flattish span in the prior three months.  And, the labor market may have begun to improve, seen in the downward trend of Unemployment Claims over the past three or four weeks.