Non-Economic Factors This Week, But...

The stock market should be dominated by non-economic factors this week -- Iran war developments,  tariff news, and the summit between Presidents Trump and Xi Jinping.  Nevertheless, last week's FOMC results had some market-supportive messages.

Among this week's non-economic factors, the Iran war is probably the most important.  Any change that results in a sharp decline in oil prices could help persuade the Fed and markets that inflation may have peaked.  In particular, the 10-year Treasury yield would likely fall below 5.0%.   

 

There was little that was new in Fed Chair Warsh’s post-FOMC news conference last week.  Regarding monetary policy, he said financial market conditions are not restrictive even after the 25 BP rate hike -- despite the economy being strong and inflation too high.  This keeps open the door for more rate cuts ahead, and the Fed's "dot" chart points to one or two more hikes this year.

 

Warsh cited the above-target 6- and 12-month moving averages of Total and Core PCE Deflator in stating that inflation is too high.  Note, however, that moving averages are backward-looking.  What may be more important is that the Fed's Central Tendency Forecasts call for inflation to move lower to 2.3-2.6% next year and then move even closer to target -- in the 2.0-2.2% range -- beginning in 2028.  Monetary policy, according to the Fed's forecasts, therefore is seen steady to softer during 2027-28.  The stock market should take some comfort in this policy outlook (at least until the data say otherwise), as it is not pointing to so much restriction to bring on a recession.  In addition, the potential for near-term rate hikes should continue to have downward influence on commodity prices and longer-term yields.

 

The markets could take a positive view of Fed policy after they see the August PCE Deflator.  The Fed staff forecasts low prints (due September 30).  The Total PCE Deflator is seen up 3.6% and Core 3.2% y/y.  These estimates imply low 0.2% m/m for Total and +0.1% m/m for Core.  To be sure, the Fed will probably have to see several months of similarly low prints to be persuaded that inflation is coming down significantly.  

 

Meanwhile, the Unemployment Claims data support Warsh's view that the labor market is strong.   Both Initial and Continuing Claims made new lows for the move down in the latest week.  At this point, they point to a speedup in September Private Payrolls.  The Atlanta Fed model's latest forecast is 5.1% (q/q, saar) for Q326 Real GDP Growth.  Real GDP rose 1.8% (annualized) over H126, in line with Fed's estimate of longer-run growth in the US.