Elections and FOMC Meeting This Week

The markets will finally see the results of the US Elections and the November 6-7 FOMC Meeting this week.  They could trade cautiously into these events.  What may be most important for the markets is whether the Presidential Election is resolved without a problem or if neither party dominates all branches of government.  The stock market could have a relief rally in either case.

To be sure, the market impact (stocks, Treasuries and dollar) of the Presidential Election could depend on who wins. But both candidates have policy proposals that are problematic for the economy and markets.  The potential implementation of these proposals could restrain a positive market impact.  Questions will remain whether the proposals will be put into effect, either legislatively or by executive order. 

Some market commentary has attributed the recent sell-off in the long end of the Treasury market to the potential for a blowout Federal Deficit, particularly if Trump is elected.  This explanation, however, may not be entirely right.  If fears of a sharply higher Deficit (and the presumed inflationary result) were the reason, the dollar should have fallen in the FX market, as well.  This did not happen.  Instead, the dollar has strengthened.  An explanation for the combination of higher long-term yields and stronger dollar could be an increasing concern about Trump's proposed tariffs.  The latter would boost the dollar on the expectation of a smaller trade deficit.  The tariffs also would boost inflation initially and thus the long end of the Treasury market through higher inflation expectations.  (Note, that the direct impact of the tariffs on prices should unwind over time as the dollar strengthens.)   If Harris wins, these market moves could unwind --  which would be a positive for the stock market.

The Fed is likely to cut the funds rate by 25 BPs at this week's FOMC Meeting.  And, while Powell should keep open the door for further rate cuts, he may be more cautious about their timing.   The economy appears to be growing moderately, but wage increases may be somewhat problematic.  Total Hours Worked in October are above the Q324 average, despite being held down by bad weather and strikes in the month.  They suggest another quarter of good-sized GDP growth, particularly taking account of a post-hurricane/post-strike bounce-back in economic activity.  The renewed downtrend in Initial Unemployment Claims in the past two weeks also suggests economic growth is fine.  The Atlanta Fed model's early estimate of Q424 Real GDP Growth is 2.3% (q/q, saar).

On the wage front, Average Hourly Earnings (AHE)  rose an above-trend 0.4% m/m in October, the second high print in the past three months.  The y/y rose to 4.0% from 3.9% in September.  The broader Employment Cost Index, in contrast, had better news.  It slowed to 0.8% q/q in Q324 from 0.9% in Q224.  The slowdown fits with the Fed's expectation of a gradual deceleration in inflation.  The ECI averaged 0.6-0.7% before the pandemic.

This week's report on Q324 Productivity/Compensation/Unit Labor Costs, however, risks adding to the labor cost problem.  Consensus looks for Compensation/Hour -- the broadest measure of labor costs -- to rise by only 2.8%, which would be a good number.  But, the risk is for a larger increase.  To be sure, speedier wages would not be inflationary if offset by higher productivity growth.  And, productivity in Q324 stands to be strong.  Consensus looks for 2.3% (q/q, saar) Productivity -- in line with the strong 2.4% average since Q123.  And, the risk is for a higher print.  But, the balance of risks between Compensation and Productivity weighs toward a higher print for Unit Labor Costs (ULC) than the consensus estimate of 0.5%.   The recent trend in ULC has been down, with the y/y hitting a slight 0.3% in Q224, well below the 1.7% y/y increase in Q423.  Anything below 2.0% suggests slower price inflation ahead.

Election Uncertainty, Earnings and Key US Data

Corporate earnings and election uncertainty should continue to dominate the stock market this week.  Although consensus looks for moderate prints for this week's key US economic data, uncertainty about the labor cost measures could dampen the market ahead of the prints.  This week's key data will be the last Fed officials see before the November 6-7 FOMC Meeting.  It is unlikely the data will deter a 25 BP rate cut, but they could influence the Fed's forward guidance at the meeting.

One of the election issues relates to Fed policy.  Trump wants the President involved with FOMC rate decisions.  This relates to Fed independence and, if he wins, would be a negative for the dollar (offsetting in part the positive impact from the threat of tariffs) and lift long-term yields, as the risk would be for political considerations to restrain rate hikes when needed to curb inflation.  

Trump supporters say the Fed makes mistakes and thus needs to be changed.  Ironically, one mistake they accuse the Fed of is representative of what Trump wants.  They accuse the Fed of not tightening soon enough in 2021-22, which they say resulted in higher inflation.  Although Fed Chair Powell attributes the delayed tightening to forecasts of a "transitory"pickup in prices, it would not be surprising if political considerations played a role.  Powell did not want to act in a way that would run counter to Congress' legislative aim to boost the economy.

This is not to say the Fed never makes mistakes.  The Fed did make mistakes in 2007-08, which exacerbated if not triggered the Great Recession.  They made 3 major mistakes:  /1/ They analyzed the problem as an illiquidity issue at banks that required interest rate cuts.  Instead, the problem really was a lack of confidence among banks regarding the extent of subprime mortgage risk in their balance sheets.  A guarantee of bank liabilities for say 5 years by Treasury or the Fed to let them unwind their subprime positions likely would have solved the problem, similar to how the ECB tackled a bank confidence problem in 2011.  Lowering interest rates in 2007-08 boosted commodity prices, particularly oil, which hurt the consumer.  /2/ Fed Chair Bernanke and Treasury Secretary Paulson went on TV to say the US economy was heading into a big recession.  This destroyed business confidence, leading to massive layoffs.  /3/ The Fed did not save Lehman Brothers, punishing the company for its mistakes rather than acting to bolster market confidence (again not understanding the confidence problem).  By the way, this is not the conventional explanation for the Great Recession.

The Fed gets into perception trouble with its Central Tendency forecasts, which are often wrong.  In a sense, the forecasts are bound to fail because markets will move in a way to prevent them from happening.  For example, longer-term Treasury yields could fall if the Fed presents a weak economic forecast.  Lower yields would lift stocks, boosting consumption as well as housing demand.  A better approach could be to publish targets for GDP Growth, Unemployment Rate and Inflation rather than forecasts.  Then, the Fed could be held accountable without seeming clueless about the outlook.

Regarding this week's key US economic data:

Consensus looks for a benign October Employment Report.  Payrolls are seen slowing sharply to +140k m/m from +254k in September, while the Unemployment is seen steady at 4.1%.  Average Hourly Earnings (AHE) are expected to slow to the 0.3% m/m trend, after climbing 0.4-0.5% in the prior two months.  Unemployment Claims data support the idea of slower job growth in October.  In addition, there were 41k additional strikers (including Boeing workers) that will subtract from Payrolls but should be added back to get a clearer picture of the underlying demand for labor.  A 180k Payrolls gain would be somewhat high from the Fed's perspective and be consistent with a lower Unemployment Rate.  Strikers, themselves, do not affect the calculation of the Unemployment Rate, as they are not counted as unemployed.  There is no evidence regarding AHE -- unfortunate since this may be the most important part of the Report.

Regarding labor costs, consensus looks for the Q324 Employment Cost Index to rise 0.9% (q/q), the same as in Q224.  Even though high from a pre-pandemic perspective, a steady pace would be tolerable.  Evidence from AHE is mixed.  AHE sped up in Q324 after slowing in Q224.  In the past 6 quarters, ECI and AHE sped up or slowed together half the time.  The other half the speedup or slowdown in ECI matched that of AHE in the prior quarter, which suggests a slowdown in the Q324 ECI. 

            (q/q percent change)

            AHE            ECI

Q324   1.06              na

Q224   0.87               0.9

Q124   1.02               1.2

Q423   0.97               1.0

Q323    0.92              1.0   

Q223    1.2                1.0    

Q123    1.1                1.2

Q422    1.2                1.1

Q322    1.1                1.2

Consensus looks for 3.0% (q/q, saar) Q324 Real GDP, in line with the Atlanta Fed Model estimate of 3.3%.  A sub-3.0% print cannot be ruled out.  Consensus also looks for the October Core PCE Deflator to rise 0.2% m/m, smaller than the 0.3% increase in the Core CPI and better in line with the Fed's 2% inflation target.  A consensus print for the Core Deflator should be a market positive.

Fed Policy Intentions Helping Stocks

The stock market is likely to continue to grind higher this week, buoyed by the Fed's intention to cut the funds rate further even with above-trend economic growth in Q324.  Indeed, the Atlanta Fed model raised its estimate of Q324 Real GDP Growth to 3.4% from 3.2% (qq, saar) after the strong September Retail Sales report more than offset the implications of the soft Industrial Production and Housing Starts reports. However, the risk of higher wage inflation could become an issue ahead.

The strength of Q324 Real GDP does not appear to have stopped the Fed from planning to cut the funds rate further, albeit at a smaller 25 BP pace from the initial 50 BP cut.  To be sure, the model's estimate may be too high.  Other data show softening in manufacturing output (mostly outside of high tech), housing starts, and Total Hours Worked.  (The official report on Q324 GDP will be released October 30.)  Even if the model's estimate is correct, the Fed's intention appears to be to bring the funds rate down to its longer-term neutral level in order to sustain solid, non-inflationary economic growth -- as long as inflation remains near its 2% target.  The Fed presumably would stop easing if if looks as if the trend in inflation has turned up.

This presumed requirement suggests that the most important part of the October Employment Report could be Average Hourly Earnings (AHE).  It would be problematic if AHE does not fall back to its 0.3% m/m trend after rising 0.4-0.5% in August and September.  Away from the Report, the recent outsized wage gains in the Boeing and Longshoremen contracts are a concern, particularly if it influences other wage demands.  The Payrolls part of the Report should be comforting for the Fed, as the Unemployment Claims data suggest (at this point) a smaller increase than the large +254k gain in September.   The Report is due on November 1.

Fed officials, including Chair Powell, insist that their policy path is data dependent.  Powell says the way to think of data dependency is in terms of the impact on the Fed's outlook.  This approach has two problems, one from the perspective of  the markets and the other from the perspective of the Fed.  The markets' problem is that the impact on the Fed's outlook is not clear.  At the extreme, the Fed's rate decisions could seem arbitrary, with little if any relationship to the data.  The Fed's problem is that its ability to forecast accurately is not particularly good.  Officials could incorrectly dismiss a strong report as one-off, for example -- thus sticking with easing instead of holding back.  They will know whether the dismissal was correct from seeing future data releases, although the more immediate reaction of the longer-end of the Treasury market can offer a hint.  For example, a sell-off in the longer end on a Fed move would hint that the Fed overdid its policy move. 

 

Stocks To Slog Up in Face of Mixed Corporate Earnings and Fed Uncertainty

The stock market will likely slog up over the next few weeks, dealing with mixed corporate earnings reports and uncertainty regarding the Fed rate decision at the November 6-7 FOMC Meeting.  A 25 BP cut is probably the best bet as of now, despite the stronger-than-expected September CPI and Employment Reports.  Expectations of modest prints for this week's US economic data -- Retail Sales, Phil Fed Mfg Index, Industrial Production -- should support this view and help stocks.  However, the most important data for the Fed will likely be the October Employment Report, due November 1.  It is too soon for evidence on Payrolls.

Fed Chair Powell has said that while the intention is to bring the Fed Funds Rate down to a neutral level over time, the pace will depend on the impact of economic data on the Fed's outlook.  The most recent data will not likely derail the Fed's expectation of slower economic growth and lower inflation.

Consensus among market observers is that the September Employment Report and CPI were stronger than the Fed liked.  My view, as discussed in last week's blog, is that the Employment Report was not as strong as appears at first glance.  It is consistent with slower economic activity at the end of Q324 and leaves open the possibility this could continue in Q4.24.  It's unlikely that Fed officials would mention the mitigating parts of the Report in their upcoming speeches, but they should be aware of them.  This week's key US economic data -- September Retail Sales and Industrial Producton --are expected to post slight gains, supporting the idea that growth is moderating.

Although the September CPI showed a wider distribution of speedier increases among components than in recent months, the Fed could discount the speedups as being part of the "bumpy" ride they expect in the decelerating trend in inflation.  Moreover, the one piece of good news in the Report was the sharp slowdown in Owners' Equivalent Rent (OER) to a below-trend 0.3% m/m.  If OER's slower pace persists, the Fed's 2% inflation target may very well be achieved.

Looking ahead to nest year, four possible scenarios are conceivable:  

1.  Aggressive fiscal policy could boost inflation expectations and longer-term Treasury yields -- raising the possibility of renewed Fed tightening.   This would be a negative for stocks.  Both presidential candidates' policies have this potential outcome.

2.  The Fed policy easing in H224 boosts economic growth and inflation in H125, raising longer-term Treasury yields and pulling in expectations of further Fed easing -- a negative for stocks.

3.  Economic growth and inflation continue to moderate, keeping Fed rate cuts on track, positive for stocks.

4.  The US economy somehow slips into recession.  This seems unlikely, unless Fed policy shifts away from easing.

A Strong September Employment Report?

The stock market should climb  this week, after Friday's ostensibly strong September Employment Report dispelled fears of recession.  However, there was less strength than met the eye in the Report.  So, along with benign inflation data expected this week, the Fed should still be on an easing path.  Although Q324 corporate earnings are expected to slow, the slowdown may be temporary.

A large increase in September Payrolls and lower Unemployment Rate were the risk, given the recent decline in Unemployment Claims.  Unless the October Report (to be released prior to the next FOMC Meeting) is as strong, the Fed will not likely stop cutting rates in Q424.  The Fed apparently is focused on its expectation of future weakness stemming from prior tight monetary policy, not current economic activity.  Moreover, although the September Report shows a strong labor market, some parts of the Report suggest the headline Payroll print may overstate strength.  Some of the jobs gain may reflect a shift toward part-time workers.

The Household Survey shows that the number of part-time workers in nonagricultural industries jumped 527k m/m in September, after a string of sub-100k increases in prior months.  To be sure, this should be viewed as only suggestive, given the relatively small sample size of the Household Survey (on which the Unemployment Rate is based) compared to the Establishment Survey (on which Payrolls are based).

A shift toward part-time workers, nonetheless, could explain the dip in the Nonfarm Workweek to 34.2 Hours from 34.3 Hours in August.  But, the dip could be just noise.  It was 34.2 Hours in July, as well, although the industry breakdown was different from that of September.  The dip in Workweek in September did not appear to be mainly among Production Workers.  Their workweek was flat.

Total Hours Worked slipped m/m because of the decline in the overall Workweek.  The Q324 average of THW is only  0.2% (annualized) above the Q224 average, versus +1.6% (q/q, saar) in Q224.   This raises doubt about 2+% Real GDP in Q324.  However, THW may overstate weakness.  This is because THW for Production Workers rose 1.0% (q/q, saar) in Q324, not much below the 1.5% in Q224.  So, Q324 Real GDP Growth still may be in the 2.0% range.  The Atlanta Fed model's latest estimate is 2.5%, but does not yet take account of Friday's data.  The next model update is on Tuesday.

The 0.4% m/m increase in Average Hourly Earnings (AHE) after an upward-revised 0.5% in August is somewhat troubling.  The Q324 average rose 4.0% (q/q, saar), compared to the 3.4% increase by the Q224 average.  The y/y rose to 4.0% from 3.9%.  Nevertheless, large wage gains were not widespread, as fewer than half of the major sectors had large increases.  AHE rose 0.4% m/m or more (on average) in only 6 of 13 sectors in Q324, versus 4 in Q224.

Consensus expects a benign print for the September CPI.  It sees +0.1% m/m for Total and +0.2% for Core.  The risk would be for a higher print if Owners' Equivalent does not fall back to 0.4% m/m after speeding up to 0.5% in August.  Consensus looks for +0.1% m/m Total and +0.2% Core for the September PPI, as well.

Consensus estimates +4.6% (y/y) for Q324 S&P 500 earnings, down from 11.2% in Q224.  The macroeconomic background appears to support a slowdown in earnings.  On a y/y basis, Real GDP Growth slowed, oil prices fell and the dollar strengthened further (thereby making foreign earnings appear lower in dollar terms).  In contrast income from abroad could help profits this quarter.  Based on the European PMI, foreign economic activity improved on a y/y basis, although it slowed q/q.  Profit margins look to have been little changed.  A soft quarter of corporate earnings could be temporary, as consensus, at this point, looks for double-digit y/y returning in Q424 and continuing through 2025.

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

Q123            2.3                -19.5                +3.0                              4.5           5.5               47.9  

Q223            2.8                -32.0                 +0.5                              4.4           5.2               44.7

Q323            3.2                -12.0                 -2.5                               4.3           4.4               43.2

Q423            3.2                -12.0                 -2.5                               4.3           3.9               43.8

 

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            2.6                  -6.0                 +2.5                              3.8           3.3               45.3                                                      

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.5% (q/q, saar).

 

How Important Are Upcoming Key US Economic Data?

The stock market should have no problem with this week's key US economic data -- if the data print close to the consensus estimates.  They would show a moderately growing economy, without putting undue stress on the labor market or lifting inflation.  Stronger-than-consensus data could lower market expectations of the size of the next Fed rate cut, and vice versa.  However,  the Fed will see another month's data before it meets again.  So, this week's releases lose some significance.  Away from the data, the stock market has major support behind it by the fact that central banks around the world are shifting to pro-growth policies.   China joined the Fed last week in monetary policy easing, and the ECB should soon do so, as well (meeting on October 17).   Market pullbacks on disappointing data (particularly in this seasonally weak period) could be buying opportunities.

Although US economic data may influence the Fed's decision on the speed of policy re-calibration, it will probably not stop the process.  The Fed's focus is on future economic activity.  Paraphrasing Chicago Fed President Goolsbee's recent comment, the economy will slow sharply ahead if the Fed does not lower the funds rate quickly.  This may not be a majority opinion at the Fed, as other officials have indicated a more cautious approach to easing.  However, the data may have to be particularly strong to preclude another 50 BP cut.  How the longer-end of the Treasury market behaves could influence the Fed's decision, as well.  Longer-term yields already have moved up a bit after the September funds rate cut.  If they move up more sharply, the Fed could settle for a 25 BP rate cut.

Consensus estimates for this week's key US economic data -- September Mfg ISM, August JOLTS and September Employment Report -- should keep a 50 BP rate cut in play:

Consensus looks for a steady 47.2 Mfg ISM.   The Index would remain below the 48.8 Q224 average, signaling a sluggish manufacturing sector.  

Consensus expects the JOLTS data to show little change in Job Openings in August, 7.65 Mn versus 7.67 Mn in July.  This would keep Openings in line with pre-pandemic levels, indicating that the post-pandemic excess demand for labor indeed has been eliminated.  The Fed views elimination of excess demand for labor as a way to hold down wage inflation without having layoffs lift the Unemployment Rate.

Consensus expects the September Employment Report to look similar to the August Report.  Nonfarm Payrolls are seen rising 145k m/m, versus 142k in August.  The Unemployment is expected to be steady at 4.2%.  And, Average Hourly Earnings (AHE) are back to a 0.3% m/m trend, after volatility in June and July (0.2% and 0.4%, respectively).  

The risk is for Payrolls to climb by more than the consensus estimate, based on the Unemployment Claims data.  Both Initial and Continuing Claims fell below July levels in August.  However, Payrolls may have to have to climb substantially, say 200k+ m/m, to raise doubt about a 50 BP rate cut.

The risks for the Unemployment Rate, are mixed.  There is a possibility of a decline, as the consensus Payroll estimate is above the 125k m/m pace consistent with a steady Unemployment Rate (assuming steady Labor Force Participation Rate).  In contrast, the Labor Force Participation Rate could resume climbing after it stabilized in August.  A higher or steady Unemployment Rate stemming from an increase in the Participation Rate would show the economy has more room to grow without stirring inflation.  Unfortunately, there is no reliable evidence regarding the m/m direction of the Participation Rate or Unemployment Rate. 

There is no reliable way to predict AHE, as well.  AHE has been in a tight 0.2-0.4% m/m range since March 2024, average 0.3%.  The same is true for all of 2023.  As long as AHE does not break to the upside of this range, it should not be a problem for the Fed.

The Atlanta Fed model still estimates Q324 Real GDP in the 3% (q/q, saar) range.  Its estimate was raised to 3.1% from 2.9% after the last couple of weeks' data.  Consumption was revised down sharply, but upward revisions in exports and inventory investment more than made up for it.  There is a possibility, however, that the downward revision to Consumption was underestimated and the upward revision to Net Exports overestimated.   Nevertheless, a near-3% pace is above trend and should be accompanied by good-sized increases in jobs.  At this point, it also suggests strong productivity growth, which should help hold down inflation.

Range-Bound Stock Market This Week?

The stock market may be range bound this week, as there are few data releases and the major indices are at or near record highs.  Although the market should be underpinned by the Fed's intention to lower rates further, there could be caution ahead of historically seasonal weakness in early October.  Also, key US economic data in early October may dampen expectations for the pace of future Fed easing.

The Fed expects to cut another 50 BPs by year end, another 100-150 BPs in 2025 and 50 BPs in 2026.  The funds rate would level off between 2.6% and 3.6%.  This week's US economic data are not expected to be a problem for this plan, but there could be problems in the following week.

The Fed appears determined to "recalibrate" the stance of monetary policy, based on Fed Chair Powell's comments at his post-Meeting news conference.  He said policy needs to be adjusted to reflect a  labor market that is no longer very tight and inflation that is close to target.  This sounds like a policy path that is set regardless of unwelcome surprises in economic data.  However, Powell said the pace of the re-calibration will depend on incoming data.  He may repeat all this in a speech this week (Thursday).

What seems to be important is whether and by how much upcoming data change the Fed's outlook -- not what the data say about the current state of the economy.  Unfortunately, it may be more difficult for market participants to ascertain the data's impact on the Fed's outlook than what they mean for the current economy.  Perhaps it will take substantial unfriendly data surprises to change the Fed's policy intentions. 

Powell indicated that what matters most are the paths of the Unemployment Rate and inflation -- the two mandated measures against which Fed policy is judged.  If economic growth is stronger than the Fed's published forecasts, it may not matter as long as the Unemployment Rate remains little changed from current levels.  This could be the case if potential growth is higher than the Fed's estimate of 1.7-2.0% longer-run growth.  With Powell repeating that the Fed expects housing rent to come down over time, small upside deviations in upcoming inflation data may be ignored by the Fed, as well.  The market and Fed are likely to take a consensus 0.2% m/m print for the August PCE Deflator in stride.

The Fed's projection of Real GDP Growth of 1.8-2.3% over the next three years is in line with its estimate of the longer-run trend, which may be "solid" as Powell says but is not especially conducive to strong earnings growth.  Like all long-term forecasts, though, these have to be taken with a grain of salt.  They may be meant to justify continued monetary policy easing rather than be a realistic forecast.

Why the projected rate cuts shouldn't lead to a significant speedup in GDP growth is a question.  Perhaps the Fed could justify it by saying the easing just offsets the lagged restraint of earlier tightening.  Or, it's possible that bad fiscal policies in a new Administration could restrain growth at the same time monetary policy is lifting it.  Arguably, the opposite happened in the past couple of years, with stimulative fiscal policy offsetting tighter monetary policy (although the Fed would never admit to this).  

The dubious accuracy of these forecasts is apparent in the downward revision of the 2024 Real GDP forecast to 1.9-2.1% from 1.9-2.3% made in June.  With H224 Real GDP Growth at 2.2% and the Atlanta Fed model estimate of Q324 Real GDP at 2.9%, there needs to be a sharp slowdown in September and Q424 to match the Fed's forecast for the year.  Perhaps, a protracted Boeing strike will do the trick.  There would be a sharp rebound in GDP once the strike ended, however.  

The latest Unemployment Claims data argue against a late-summer slowdown.  Initial and Continuing Claims fell further below the August levels in the latest week, despite the possibility of a post-holiday rebound.  At this point, they suggest a speedup in September Payrolls (due October 4), which could dampen expectations of future Fed easing.