CPI, Labor Market and Fed Monetary Policy

The stock market may trade cautiously as it moves into the corporate earnings season this week, with the softer macroeconomic background suggesting uneven reports (see the June 29 blog).  Moreover, tariff developments could keep the market on edge, as could Administration pressure on Fed Chair Powell to resign.  Nevertheless, there are reasons to be optimistic about the market.  Tuesday's June CPI Report could lift expectations of a Fed rate cut at the July 29-30 FOMC meeting.  A rate cut would likely still be a long shot, unless there is some pullback in announced tariffs.  Europe's decision not to retaliate at this point is encouraging that a trade deal will be reached before the August 1 deadline -- a market positive.  However, it remains to be seen whether this will be the case.

Consensus looks for +0.3% m/m for both June Total and Core CPI.  This would be a bit on the high side and not lift expectations of a near-term Fed rate hike.  A consensus or higher print would likely reflect some impact from tariffs.  Also, Airfares should not be as weak as in April and May, since seasonal factors turn neutral after depressing them in those months.  However, a lower print for Core can't be ruled out.  Owners' Equivalent Rent needs to stay low at 0.3%.  More generally, importers may have lowered prices to offset some of the tariff and maintain market share.  And, the subdued wage inflation in the US, as seen in the June Employment Report, could help hold down price increases.  

While a low CPI print could fan expectations of a near-term Fed rate cut, the latter is still probably a long shot.  The June FOMC Minutes indicated only a couple of participants considering a July easing.   Most of the FOMC members were focused on inflation risks stemming from tariffs.   And, Trump's latest spate of large tariff announcements could make these members even more concerned.

The latest Unemployment Claims data have mixed implications about the labor market, but are not likely to concern Fed officials.  Initial Claims remain below the June average for the third week in a row, suggesting a pullback in layoffs.  In contrast, Continuing Claims are still high, suggesting that companies are reluctant to hire.  Uncertainty about the impact of tariffs could be weighing on hiring decisions. 

Despite the divergence between Initial and Continuing Claims, if both stay at their latest respective levels for the next few weeks, they would point to a speedup in July Payrolls -- outside of government jobs, which could drop as state & local education jobs unwind their June jump and some of the Trump cuts in federal government jobs show up.  Although the July Employment Report will be released after the next FOMC Meeting, the current levels of both types of Claims are probably not high enough to change the Fed's view of a solid labor market.  

Looking ahead, the imposition of tariffs could have two, opposite impacts on the labor market.  Relocation of US production from abroad should boost demand for labor.  However, the drag on demand for goods and services from higher prices should depress it.  The latter could have the more immediate impact, since it takes time to shift production to the US.  Another major factor whose impact on labor demand is likely to increase over time is the substitution of AI for workers.  So far, there is anecdotal evidence that this is happening.  The negative impacts on the labor market from these two channels could result in Fed easing at some point.

Away from the economy, a possibly significant hit to the stock market would likely result if Trump succeeds in removing Powell from the Fed Chair.  The "manufactured" controversy over the Fed's new headquarters could be the catalyst.  With a new Trump appointee expected to be quicker to cut rates, longer Treasury yields should rise and the dollar fall.  The former, particularly, would hurt stocks.

  

 

 

 

 

 

 

 

 

 

 

 

Misleading Tariff Deadline (?) and June Employment Report

The stock market has to contend this week with the July 9th deadline for trade negotiations.  However, there are a couple of reasons why a pullback could be modest.  First, Trump has said this deadline is not set in stone.  And, the Administration will be sending letters to some countries threatening an August 1st implementation of high tariffs if there is no trade agreement in place by the deadline.  This threat could keep alive hope for a market-positive resolution in July.   Second, the June Employment Report in fact should sustain hope for a Fed easing that should continue to provide underlying support for the market.

Although the headline prints for the June Employment Report appeared to be strong and belie the need for Fed easing, the real story is that the Report was weak and argues for a rate cut.  The stronger-than-expected +147k m/m increase in Nonfarm Payrolls was lifted by a 73k jump in Government Jobs.  A bounce in State & Local jobs more than accounted for the latter, with education jobs mostly responsible.  There may have been a mismatch between seasonal factors and school-year end this month.  More importantly, Private Jobs slowed sharply to +74k from +137k in May.  At the same time, the Nonfarm Workweek fell to 34.2 Hours from 34.3 Hours.  As a result, Total Hours fell  0.3% m/m and are 0.5% (annualized) below the Q225 average -- a weak take-off point for Q325.

The dip in the Unemployment Rate to 4.1% from 4.2% also belies labor market strength.  The decline resulted from a drop in the Labor Force, as the Participation Rate fell.  Civilian Employment rose a modest 93k m/m.  A lower Labor Force Participation Rate could reflect discouragement about job opportunities.  Including Discouraged Workers, the Unemployment Rate was steady at 4.5%.

Wage inflation seems to confirm a softening labor market.  Average Hourly Earnings slowed to 0.2% m/m from their recent trend of 0.3%.  The slowing was fairly widespread, as more than half of the major sectors saw AHE equal to or below their Q225 average.  On a quarterly average basis, AHE is on a slow downtrend:

                                Average Hourly Earnings (quarterly average of m/m % changes)

                                               Q225        Q125        Q424        Q324 

                                                 0.27          0.30            0.37        0.40 

Despite the weak ending of Q225, it still looks like economic activity bounced noticeably on a q/q basis.  Total Hours Worked in Q225 rose 1.8% (q/q, saar) after +0.7% in Q125.  The bounce could be attributed to a return to trend after bad weather held economic activity down in Q125.  The Atlanta Fed Model's latest projections is 2.6% for Q225 Real GDP Growth.  Real GDP fell 0.5% in Q125.

Meanwhile, the Unemployment Claims data so far don't suggest the weak ending of Q225 is snowballing.  Claims appear to have stabilized during June.  So, sluggish economic growth in Q325, rather than recession, remains likely -- which would not stop a Fed easing at some point.

 

 

 

 

 

Four Major Issues Facing the Stock Market

The stock market rally may pause or slow its ascent this week as it braces for several hurdles this summer.  The latter relate to the following issues: /1/ Will Trump extend the tariff postponement, /2/ Will the Fed ease,  /3/ What will be the outcome of the Tax/Spending Bill? and  /4/ How strong are Q225 corporate earnings.  Hope for a Fed easing at some point should temper a negative market reaction to an adverse outcome for the other three, if that's the case.  

At this point, it's unclear what Trump will decide to do when his 90-day tariff postponement expires, as he said they are not set in stone.  Expiration date for many of the countries is on July 9.  Postponement of Chinese-specific tariffs ends on August 12.  In addition, Trump has threatened to impose tariffs on a number of goods, which have not yet been set.  And, a Federal Appeals Court is weighing the decision of the Court of International Trade that tariffs on Canada, Mexico and China as well as "reciprocal tariffs" are illegal.  So far, from a positive perspective, Europe said a trade agreement with the US ahead of the deadline looks doable, with European purchases of US-made weapons the key.  Trump's ending of trade talks with Canada, though, although possibly a bargaining ploy, shows there are still hurdles to a more general resolution.    

Postponement or ending tariffs (presumably if the Appeals Court rules against them) would mitigate or remove a major concern that is keeping the Fed from easing.  Indeed, the macro background would not stand in the way of rate cuts,  Inflation appears to be easing as measured by the CPI and fairly steady as measured by the PCE Deflator.  And, economic growth is slowing.  The Atlanta Fed Model's forecast of Q225 Real GDP Growth is now 2.9%, down from 3.4%, with Consumption slower than expected.  Nevertheless, the Fed would likely be agreeable to some economic softening to prevent a wage-price spiral from developing as a result of tariffs.  So, Fed Chair Powell is likely to repeat his message that Fed monetary policy is now on hold at this week's ECB-sponsored meeting of central bankers.

Nevertheless, this week's June Employment Report is expected to support the idea of slowing growth.  Consensus sees +110k m/m in Nonfarm Payrolls, versus +137k  in May, and an uptick in the Unemployment Rate to 4.3% from 4.2%.  (Payrolls averaged 111k and Unemployment Rate 4.1% in Q125.)  Unemployment Claims data suggest the risk of softer prints for both Payrolls and Unemployment compared to May's.  Average Hourly Earnings are seen slowing to 0.3% m/m from 0.4%.  This would put them back to trend and is a positive for stocks.

Most of the public debate about the Tax Bill centers on the impact of the federal deficit over the next 10 years.  The Congressional Budget Office's (CBO) 10-year baseline projection assumes that Trump tax cuts will expire, consistent with current law.  CBO estimates that just extending them (along with the other provisions of the Bill) would boost the cumulative 10-year deficit by $4 Tn to $26 Tn.  This projection is a factor lifting longer-term Treasury yields.  However, the problem with not extending them is that the sequential jump in taxes would hurt economic growth.  So, it is more than likely that the tax cuts will be extended.  The other provisions of the tax bill, cutting Medicaid, food stamps, etc., would probably exert a modest drag on consumption and not hurt stocks much if at all.  In contrast, increased Defense Spending already is boosting growth, as seen in May Durable Goods Orders.  Defense Orders Excluding Aircraft rose sharply in both April and May, more than accounting for the increases in overall Ex Transportation Orders.  

Consensus looks for Q225 S&P 500 corporate earnings to rise about 5.0% y/y, well below the near-13% increase in Q125.  The macro evidence backs expectations of slower profit growth, as it is not as strong as in Q125.  US economic growth slowed further.  Profit margins may have narrowed, as the Core CPI rose by less than Average Hourly Earnings.  And, lower oil prices should have hurt oil companies.  On a positive note for profits, economic growth sped up abroad and the dollar was less strong -- so it cut the dollar value of earnings abroad by less on a y/y basis than in Q125.

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

 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            2.7                  -6.0                 +2.5                              3.8           3.2               45.3     

 

Q424            2.5                   0.0                 +3.5                              4.1           3.4               45.4       

 

Q125            2.1                  -6.5                +6.0                               3.9           3.1               47.6                                       

Q225            2.0                -16.0                +3.4                               3.9           2.8               49.3     

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.9% for Q225 (q/q, saar).

 

  

Caution After Iran Bombing, But Hope For Fed Easing

The stock market may trade cautiously this week, concerned about fall-out from the US bombing of Iranian nuclear facilities.  Most of this week's US economic data are expected to be on the soft side, sustaining stock-supportive expectations of Fed easing in H225.  And, the early signs from the Unemployment Claims data suggest a slower jobs gain in the next Employment Report, due July 3.  However, Fed Chair Powell's Congressional testimony this week could temper expectations of a near-term Fed easing as it should not diverge significantly from his post-FOMC news conference last week.  

Most of this week's US economic data are expected to be soft.  Consensus looks for declines in both New and Existing Home Sales for May.   May Durable Goods Orders are expected to show a small 0.1% m/m increase in the underlying Ex Transportation Orders.  And, the June Conference Board Consumer Confidence Index is seen up only slightly, remaining among the recently low levels.  May Consumer Spending is expected to speed up a bit to 0.3% m/m from 0.2% in April, but there could be downside risk as well as risk of downward revisions to the prior two months.  The May Core PCE Deflator is seen up 0.1% m/m, in line with the low CPI.  The y/y should stay at 2.5%.  For the Core PCE Deflator to end the year at the the Fed's lower-bound 2.9% Central Tendency Forecast, it has to average a bit more than 0.2% m/m for the rest of the year (including May's).

The latest Unemployment Claims data support other evidence pointing to slower economic growth after the post-winter bounce in April.  Both Initial and Continuing Claims are above their respective May average in the last week or two.  If they stay at these levels, they would point to a smaller increase in Nonfarm Payrolls in June than the +139k m/m in May.  

The Fed's cautious outlook for inflation reflects their fear that tariffs will boost inflation in coming months.  In this week's Congressional testimony, Fed Chair Powell will likely repeat the points he made at his post-FOMC news conference last week.  He said the Fed expects a large amount of the tariff impact will show up in the next few months' inflation data, but it is hard to predict how the tariffs will work through the various parties -- importers, exporters, retailers, consumers, etc.  They may not be fully passed through.  So, the Fed is waiting to see what the net outcome will be.  

Powell should say that economic growth may be slowing.  Real GDP Growth in H125 so far looks to be 1.6% (saar), taking account of the latest Atlanta Fed Model's 3.4% for for Q225 and the actual -0.2% in Q125.  The H1 pace is slightly above the Fed's 1.2-1.5% Central Tendency Forecast for the year -- revised down from the 1.5-1.9% March Forecast because the magnitude of the threatened tariffs now is higher than what it was when the March forecasts were made.  It suggests the Fed sees a H2 slowdown from the H1 pace.  

Although Powell may face criticism from some in Congress (similar to Trump's) about refraining from easing in the face of expected slower economic growth, the Fed's reluctance is consistent with the optimal policy I described in my April 6 blog.  Aiming for slow growth while tariffs are implemented would help prevent a wage-price spiral from developing.  Without wages trying to catch up to tariffs, the latter would just have a one-off impact on prices.  The wage data in the June Employment Report could be important in the Fed's deliberations.

 

 

 

A Friendly FOMC?

The stock market may resume its rally this week, as the Israeli-Iran attack may move to the background at least for now and the Fed becomes center of attention.  There is a possibility the Fed may begin to tilt toward an easing at this week's FOMC Meeting.  This could be seen in the Statement as well as in Fed Chair Powell's post-FOMC news conference.  

The FOMC Statement might tone down its description of inflation, given the low CPI prints of the past two months.  In May, the Statement said, "Inflation remains somewhat elevated."  Perhaps this remains true for the Core PCE Deflator on a y/y basis, but not the Total PCE Deflator (see below).  The Statement also might modify its description of the balance of risks.  In May, it said it "judges the risks of higher unemployment and higher inflation have risen."  Tariff-related risks to both remain, but the evidence is building towards the former rather than the latter

The Fed is in a delicate situation with regard to monetary policy.  The latest evidence of slowing inflation and possibly slowing economic growth opens the door for rate cuts at some point.  However, a Fed shift in that direction risks the impression of bowing to political pressure from Trump.  To be sure, even a hint that the next move will be an easing could elicit a complaint from Trump that the Fed is dragging its heels.  And, it is likely that any hint would probably be balanced by tariff-related uncertainty.  Still, any hint of easing would be a market positive.

The US economy appears to be evolving along the lines of, if not better than, the Fed's Central Tendency Projections made in March (see table below), which embody expectations of 1-2 rate cuts in H225.  Real GDP Growth in H125 is 1.8%, assuming the Atlanta Fed Model's latest projection of 3.8% for Q225 (after -0.2% in Q125).  The 1.8% H125 average pace, which smooths out weather and other temporary effects, matches the Fed's estimate of the longer-run trend in Real GDP.  Meanwhile, inflation is behaving better than expected by the Fed.  April's y/y is 2.1% for the PCE Deflator and 2.5% for Core -- both below the Central Tendency Forecasts.  Powell may bite the bullet and recognize the desired behavior of the US economy and what it implies for monetary policy.  

                                      Fed's Central Tendency Projections for 2025 (Q4/Q4 % Change) 

 Real GDP Growth                  1.5-1.9      

PCE Deflator                           2.6-2.9  

Core PCE Deflator                  2.7-3.0 

Evidence pointing to a slowdown in economic growth from the Q225 pace is building.  Initial and Continuing Unemployment Insurance Claims have climbed over the past three weeks.  The latest week's Claims data are above their respective May averages.  This week's US economic data could add to this evidence.  In particular, consensus looks for a slight 0.1% m/m increase in May Ex Auto Retail Sales, the same as in April.  Not too much should be made of a soft print, since it could be attributed to the typical pause after a strong month (March).  Nevertheless,  it would keep open the door for slower growth ahead.  In contrast, a large gain could bolster expectations of a sustained strong pace of economic activity. 

  

 

Inflation Next, Growth and Federal Deficit in Background

The stock market may continue to rally this week, as US inflation data are expected to remain contained despite the beginning impact of tariffs and a post-winter rebound in economic activity.  Controversy over Trump's tax bill should bubble in the background, with a self-imposed passage deadline of July 4.

Consensus expects a moderate May CPI, with Total up 0.2% m/m and Core up 0.3%.  This month's report should begin to pick up the pass-through of Trump's tariffs to prices.  However, other forces are at work, as well, including subdued oil prices, compositional shifts in demand for goods and services, and contained wage inflation.  In particular, all three factors and seasonal factors could depress airfares again, as they did in the prior two months.   Also, housing rents may be finally reflecting the softness seen in private surveys months ago.  So, a lower-than-consensus May CPI can't be ruled out.

The May Employment Report confirmed a post-winter rebound in economic activity in Q225 but left open the door for slower growth in Q325.  Total Hours Worked (THW) in May stood 2.4% (annualized) above the Q125 average, markedly better than the +0.7% (q/q, saar) pace in Q125.  This is consistent with the Atlanta Fed Model's latest estimate of +3.8% (q/q, saar) Real GDP Growth in Q225, assuming a boost from productivity.  However, THW in May were only 0.2% (annualized) above the April-May average.  Unless there is a bounce in at least one of the next few months, THW could slow sharply in Q325.  The still-high level of Unemployment Claims for the second week in a row supports this possibility.

The Employment Report also showed that wage inflation remained in its recent range.  Although Average Hourly Earnings ticked up to 0.4% in May, this followed a low 0.2% in April.  The April-May average is 0.3%, equal to the recent trend.  And, the uptick in the unrounded Unemployment Rate to 4.24% from 4.19% suggests upward pressure on wages remains modest.  The question ahead is whether tariff-related boosts to prices lead to a ratcheting up in wage demands as labor tries to recoup its purchasing power.

There are two aspects of the Federal Deficit debate that are relevant for the markets.  One is the sequential change in the Deficit.  The other is the longer-run sustainability of US debt, that is whether investors -- domestic and foreign -- will want to hold the debt around the current level of interest rates.   

A sequential decline in the Federal Deficit would hurt US economic growth.  There would be a substantial drag if the 2017 tax cuts are not extended.  Cuts in Federal subsidies and transfer payments would hurt growth, as well.  An extension of the tax cuts would have little impact on growth, as there would be no increase in fiscal thrust.

The longer-run sustainability of the Federal Deficit has been an issue forever.  So far, the US economy has not collapsed as a result.  Continuing Federal Deficits have been possible because the US dollar is the most important global currency and foreigners need it, either for transactional or storage purposes.  

Investors have been willing to hold US debt and other assets, in part because of a reliable legal system, respect for property rights, and a government constrained by checks and balances in the US.  If investors lose faith in US institutions or policies, then the huge amount of outstanding debt will be a problem.  The sale of US assets -- stocks, bonds and currency -- would push the US economy into recession.  It's not clear the Fed would be able to withstand it if the magnitude of selling is large.  So, while cutting the Federal Deficit would likely be viewed positively by the markets,  if it is not, doomsday prognoses are probably overdone as long as US institutions remain highly respected.  The Fed's independence is one such institution that needs to be maintained.

 

 

   

 

 

  

The Economic Picture In The Background

The stock market is likely to continue being pushed around by positive and negative developments in the tariff war.  Nevertheless, the market still has its eye on the economy in the background, looking for evidence that the tariffs, either themselves or uncertainty surrounding them, damage growth prospects.  This week's key US economic data are not expected to provide such evidence,  Both the May Employment Report and Mfg ISM are seen indicative of moderate economic growth.  So, the macro background is still supportive of stocks.

Consensus looks for a slowdown in Nonfarm Payrolls to +130k m/m in May from +177k in April.  The expected May pace would be consistent with a steady 4.2% Unemployment Rate, which is the consensus estimate.  Such a level of unemployment is historically low but shows some slack relative to last year.  And, as Fed Chair Powell has said, there is little evidence that wage gains have generated inflationary pressures.  That is, a wage-price spiral is not evident.  The consensus estimate of +0.3% m/m for Average Hourly Earnings is consistent with the Fed's 2% inflation target, taking account of trend productivity growth.  The y/y would fall to 3.7% from 3.8% if consensus prints.

The Claims data support the idea of a slowdown in May Payrolls.  Both Initial and Continuing have trended above their levels in the April Payroll Survey Week, suggesting a pickup in layoffs and softening in hiring.  Both jumped in the latest week, but more weeks at the higher levels are needed to confirm their  import.

The consensus estimate of a steady 48.7 for the May Mfg ISM would be consistent with sluggish but non-recessionary growth in the manufacturing sector.  It would remain below the 50.1 Q125 average.  This sector is particularly vulnerable to the tariff war, impacted by higher input costs and potential loss of export markets.  To be sure, the weaker dollar could have helped some industries,

The Atlanta Fed Model's latest projection of Q125 Real GDP Growth is a strong 3.3% (q/q, saar).  The strength largely reflects the drop in April Imports.  This is a mirror image of what happened in Q125, when a surge in imports pulled down Real GDP to -0.2%.  Both figures likely reflect measurement problems when there are large swings in imports.  The best way to evaluate recent GDP Growth is to average the two quarters.  Using the latest Atlanta Fed Model estimate, Real GDP Growth in H125 is about 1.5%.  This is close to the longer-run trend estimated by the Fed and is not an inflationary pace.