Next Market Focus -- Trump Tariffs, CPI and Q424 Corporate Earnings

Stocks may continue to trade cautiously this week as Trump's inauguration (January 20) approaches.  So far, his policy pronouncements have not been market-friendly and the risk is they will stay that way.  There is a scenario, however, in which Trump's policies may be market positive, as discussed below.  The market also will be facing December inflation data and the start of Q424 corporate earnings.  Both are expected to be decent.  So, there could be relief bounces while the overall tone is cautious.

The market focus will likely be on Trump's decision regarding how to proceed with imposing tariffs.  For example, a 10% tariff on all US imported goods would amount to about $200 Bn for the year.  A 25% on goods imports from Canada and Mexico would amount to about $230 Bn.  A full pass-through to prices in either example would boost the PCE Deflator by about 1.0%.  This impact would be mitigated if importers absorb some of the tariffs by lowering profit margins.  Also, the stronger dollar is an offset.   

In any case, there may be silver lining for the markets.  Trump could tie the revenue from tariffs to an overall goal of holding down, if not reducing, the federal deficit.  To be sure, he will probably aim to extend the expiring tax cuts of his first Administration, but he'll also talk about cutting federal spending. 

Emphasizing the goal of reducing the federal deficit could spark a rally in the long end of the Treasury market and stocks.  A precedent is the Clinton Administration in the 1990s.  The then Treasury Secretary, Bob Rubin, always would mention deficit cutting in his speeches and press conferences -- which would induce a positive response in the bond market and stocks.  The federal budget went into surplus during the Clinton years, helped in part by huge inflows of capital gains taxes stemming from the stock market.

Consensus looks for 0.3% m/m Total and 0.2% Core CPI for December.  Even though gasoline prices fell at the pump in December, they did not fall as much as seasonal factors expect.  So gasoline prices (seasonally adjusted) should be up fairly sharply, boosting the Total.  A 0.2% Core may require Owners' Equivalent Rent remaining at a low 0.2 as well as Lodging Away From Home and Used Car Prices flattening after they jumped in November.  There is some evidence suggesting this may be the case for Used Car Prices.  The extent of holiday discounting is important, as well.  However, the greater the discounting, the greater the potential snap-back in January or February as normal pricing reasserts itself.

A benign 0.2% Core CPI should be a market positive, as it would suggest the strong labor market, as seen in Friday's December Employment Report, can be tolerated by the Fed in its fight against inflation.  The latter was suggested already by the downtick in December Average Hourly Earnings to 0.3%  from 0.4%.  However, a cautionary note is that long-term inflation expectations have moved up.  This is seen in Friday's report of 3.3% for University of Michigan's 5-Year Inflation Expectations measure,   It broke above its recent 3.0-3.1% trend.

Consensus estimate for Q424 S&P 500 earnings is in the high single-digit to low double digit range, better than the mid-single digit increase in Q324.  The macroeconomic evidence suggests some downside risk.  /1/ Profit margins may have narrowed, as wages sped up by more than prices.  /2/ Real GDP Growth is slightly lower in Q424 than Q324 on a y/y basis.   /3/ And, earnings from abroad should be hurt a little more by the stronger dollar and softer foreign economic growth.  In contrast, oil prices stopped falling (y/y), which should help that sector. 

                                                                                                                                        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            2.7                  -6.0                 +2.5                              3.8           3.2               45.3     

 

Q424            2.6                   0.0                 +3.5                              4.0           3.3               45.4                             

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.7% for Q424 (q/q, saar).

Upcoming Macroeconomic Data Market Friendly?

The stock market may very well move move up in the next week or two, as the macroeconomic data are expected to be market friendly.  The key data are seen showing moderate growth and inflation, a good combination now that the Fed is likely to be on hold for awhile.  Market caution may reassert itself as the Presidential inauguration on January 20 gets closer.

Consensus expects a near-trend December Employment Report.  Nonfarm Payrolls are seen rising 150k m/m and the Unemployment Rate steady at 4.2%.  A near-consensus increase would be between the 3-month average ( 173k) and the October-November average (132k).  (Note that October and November were impacted by strikes and bad weather, which should be cancelled out when the two months' jobs gains are averaged.)  An uptick in the Unemployment Rate can't be ruled out, as the Rate rounded down from 4.245% in November -- "noise" in the data could push the headline print up to 4.3%.  Consensus looks for a return to 0.3% m/m in Average Hourly Earnings.  This would be a favorable print for the markets and Fed, after AHE averaged 0.4% in the prior 4 months.

The November JOLTS data are expected by consensus to show a dip in Job Openings, with the Total being close to pre-pandemic levels.  A dip would indicate some softening in demand for labor.  It will be interesting to see if Hires soften, as well.  Continuing Unemployment Claims have hinted as such in recent weeks, adjusting roughly for holiday effects.

Last week's release of the December Mfg ISM offered evidence of moderate economic growth.  The 49.3 print is in line with a gradual (albeit uneven) improving trend since July.  It exceeded both the Q424 average (48.1) and the Q324 average (47.1).  This kind of gradual improvement should be market friendly (for both stocks and bonds), assuming the Fed is on hold.  Moderate growth is good for the profit outlook while still being non-inflationary.  The Mfg ISM Survey results do not call for tighter monetary policy. 

Indeed, the Atlanta Fed model's latest estimate of Q424 Real GDP Growth is 2.4% (q/q, saar), which, if correct, should keep Fed's policy intentions unchanged -- that is, keeping open the door for modest easing next year.  This pace is just above the longer-term trend estimated by the Fed.  It would put the 2024 (Q4/Q4) growth rate at 2.5%, matching the Fed's Central Tendency Forecast.  It should give the Fed more confidence in its forecast of 1.8-2.2% in 2025.   

 

 

Caution Ahead of Trump?

The stock market may experience bouts of profit taking into the new year, as it turns cautious ahead of potentially negative developments coming from the new Trump administration.  The threat of tariffs and possible retaliations are foremost among these risks. 

However, market pullbacks may be just volatility within a wide trading range for several reasons:  /1/ Some actions by the new administration, such as deregulation, could be market positive.  /2/ News reports indicate that Mexico has begun to stop immigrants at its southern border and that Canada has begun to better police its border.  Both developments suggest Trump may hold back from imposing tariffs on them.  /3/ US economic data are likely to continue to show moderate growth and inflation.  However, economic growth appears to be skewed toward high tech.  And, there are pockets and hints of softness elsewhere that should keep the door open for more Fed rate cuts ahead.  /4/ Q424 corporate earnings are expected to be strong.

Two important data releases this week are the December Mfg ISM and the weekly Unemployment Claims.  Consensus looks for little change in the Mfg ISM from 48.4 in November.  This level indicates sluggish manufacturing activity, but continuing growth in the overall economy.  The survey includes a measure of export and import orders, so could be an early indicator of any impact from the recently very strong dollar.  The survey showed little, if any, effect in November, as export orders improved while import orders softened -- contrary to the implications of the strong dollar (as well as the possibility that imports are being accelerated ahead of tariffs).  The official trade deficit data show both exports and imports rebounding in November from October's declines.  On a y/y basis, imports are still running well ahead of exports (+9.6% versus +6.1%). 

The manufacturing sector is not only sluggish but skewed toward high tech, according to the Fed's Industrial Production data (see table below).  Output has been falling overall with the major exception being high tech (computers, semiconductors and communication equipment).

The Unemployment Claims data have been mixed.  Initial Claims are down slightly so far in December, but within the range seen since September.  They show a leveling off of layoffs.  In contrast, Continuing Claims rose in the first week of December (latest week of data), after rising in both October and November.  They suggest a slowdown in hiring.  It is too soon to say what these data suggest about December Payrolls.  If they stay near the latest levels, they would suggest a smaller Payroll increase than the +227k m/m in November.

                                                                        (percent change)

                                                Aug to Nov (annualized)       Nov 23 to Nov 24

Mfg Output                               -4.0                                              -1.0                  

High Tech                                    4.7                                               7.4     

Motor Vehicles                           -9.1                                              -3.5 

 Other                                         -4.0                                              -1.0     

Fed on Hold, Washington Now The Issue

The stock market rally looks to be intact after last week's extreme volatility.  Although news commentary blamed the Fed for last Thursday's sell-off, the budget crisis was likely the real culprit.  The FOMC Meeting outcome was essentially as expected and arguably a market positive, while Trump's opposition to the proposed budget resolution was not on either count.  Although the budget issue was eventually resolved, Trump's opposition highlighted the possibility of more discord in Washington, which would not be good for stocks ahead.  In particular, the potential for a trade war between the US and its major trading partners could weigh on stocks at some point.

The bottom line from this week's FOMC meeting was not bad for the stock market.  The Fed's downshift in next year's projected pace of rate cuts should not have precipitated such a sharp drop in stocks.  First, it was widely expected.  Second, one reason for the downshift was the continuing strong US economic growth -- a market positive.  Moreover, Fed Chair Powell's comments suggest the Fed will act if needed to sustain the strong growth next year -- reducing downside risks in the outlook.  Along with the likelihood of policy easing by other central banks, the overall stance of monetary policy appears to be pro-growth globally.  

Although the Fed raised its inflation forecast a bit for 2025, Powell emphasized that officials are confident that the trend is down and that their 2% target will be met.  His comments suggest the Fed will continue to downplay outliers and quirks in inflation data, such as the tendency for start-of-year price hikes.  The modest 0.1% m/m prints for November PCE Deflator offers support for his outlook.

Despite Powell's insistence that policy is based on the economic outlook, the Fed's forecasts have little credibility.  They consistently failed to pick up the economy's strength this year.  Even the latest forecast of 2.4-2.5% for 2024 Real GDP Growth appears too low,  Real GDP Growth would be 2.7% in 2024 (Q4/Q4) if the Atlanta Fed's forecast of 3.1% for Q424 is right.  In the same vein, the Fed's projection of two rate cuts in 2025 shouldn't be viewed seriously.  Whether and by how much rates are cut will depend on how the economy evolves, which no one (including the Fed) knows for sure.  At this point, the significance of its rate projection is that monetary policy leans toward pro-growth, ready to ease further if the economy weakens.

Powell said that Fed staff has been working to determine the potential channels through which tariffs could impact the economy.  He admitted that the impact on inflation and growth is not clear, in part because it could depend on whether other countries retaliate.  Other issues are whether the tariff's impact on inflation would be one-off or sustained.  The continuing strengthening of the dollar is already an offset.  A trade war would be a problem for stocks, even if the effects on the economy are not seen immediately or turn out to be minor. 

 

 

 

 

This Week's FOMC Meeting

This week's FOMC Meeting should not derail the stock market rally.  To be sure, Fed Chair Powell has continued to state that monetary policy decisions are data dependent, and the latest data -- showing solid growth and slightly elevated inflation -- argue for steady policy.   (Note that this week's US economic data are expected to fit this description, including  stronger November Retail Sales, Industrial Production and Housing Starts, as well as a benign PCE Deflator).  However, the Fed's focus appears to be on next year, not the current state of the economy.  And, Powell has made clear that officials believe its policy stance is too tight, with the risk that growth will slow too much ahead.  So, there is a good chance the Fed will cut by 25 BPs to 4.5-4.75% at the Meeting, while indicating, most likely in Powell's post-Meeting press conference, that the solid growth we're seeing means the Fed can take its time in adjusting the funds rate down to a non-restrictive level.

The revisions to the Fed's Central Tendency Forecasts, including the "dot" charts, may point to fewer rate cuts in 2025 than they had in September.  At the September FOMC Meeting, a majority of participants expected the funds rate to end 2025 in the 3.0-3.5% range.  Upward revisions to forecasts of Real GDP Growth and Inflation, as mentioned in last week's blog, would support a less aggressive approach to easing policy.

Nevertheless, last week's inflation data contained elements that should give the Fed hope that its 2% inflation target will be met at some point.  Although the CPI rose a high 0.3% m/m in November, a couple of outliers -- Used Car Prices and Hotel Rates -- were responsible for preventing a 0.2% print.  More encouraging was the slowdown in Primary Rent and Owners' Equivalent Rent to 0.2%.  Continuation of these rent components at this modest pace would increase the odds that the Fed's target will be met.  Also, the share of CPI components with 0.3% or higher prints fell to 44% from 56% in October, still high but moving in the right direction.  

Not surprisingly, the markets did not pay much attention last week to a normally ignored data release -- the revision to Compensation/Hour in the prior two quarters.  This time, however, the revisions were important as they undercut concern about inflationary pressures stemming from labor costs.  Compensation/Hour -- the broadest measure of labor costs -- was revised sharply lower, pushing down Unit Labor Costs (see table below).  They now look to be running well below the paces seen in 2023 --  in 2023 (Q4/Q4) Compensation/Hour rose 4.8% and Unit Labor Costs rose 2.1%.  These revisions should be a relief for Fed officials and bolster their confidence that inflation is on a downtrend.

 Compensation/Hr  Unit Labor Costs

q/q saar y/y q/q saar y/y

Q324

Revised 3.1 4.3 0.8 1.3

First-Print 4.2  5.5 1.9 3.4

Q224

Revised 1.0 4.8 -1.1 2.2

First-Print 4.6 5.7  2.4 3.2

 

Recent Data Good for Stocks

The stock market should continue its rally into year end, even if the Fed does not cut rates at the December 17-18 FOMC Meeting.  Economic growth is solid and inflation is somewhat elevated, which are market-positives despite the possibility of steady Fed policy.  In addition, potential negatives stemming from Trump's tariff threat are too far ahead to pose a near-term problem for the market (but this could change in Q125).  And, there is still a possibility that Mexico or Canada may agree to Trump's demands regarding immigration and drug flows before the tariffs are implemented.

The November Employment Report did not change the story of solid economic growth and somewhat elevated inflation.  Smoothing out the impacts of weather and strikes,  Total Hours Worked look to be up 0.7% (q/q annualized) in Q424, which would a tad higher than the 0.6% in Q324.  If Productivity Growth is the same in both quarters, Real GDP Growth should be close to the 2.8% seen in Q324.  The latest Atlanta Fed model estimate is 3.3%.  Wage inflation remained somewhat elevated in November.  The 0.4% m/m increase in Average Hourly Earnings matched the higher pace seen since August.  AHE probably have to trend at 0.3% or less to be consistent with the Fed's 2% inflation target.  A positive is that the unrounded increase in AHE was 0.37% in November, down from 0.42% in October.  

The Fed is likely to support a decision to keep rates steady by lifting its Central Tendency forecasts.  The latest data suggest /1/ the forecast of Real GDP Growth in 2024 would be hiked to about 2.7% from 2.1%, /2/  The forecast of the Q424 Unemployment Rate lower at 4.1-4.2% from 4.3-4.4%, and /3/ the PCE Deflator forecasts 0.1-0.2% points higher.  Stronger forecasts could be made for 2025, as well.

This week's inflation data are not expected to change the story.  Consensus expects the November CPI to post an increase of 0.2% m/m for Total and 0.3% for Core -- the same as in the prior 3 months.  The y/y would edge up to 2.7% for Total and be steady at 3.3% for Core.  To be sure, the same potential for lower prints exists as has been the case in the past couple of months.  It would likely require Owners' Equivalent Rent to slow to 0.3% from 0.4% and more subdued prints for volatile components such as Used Car Prices and Airfares.  These conditions were not met in the past couple of months.  Moreover, the dispersion of price increases moved up over the past couple of months, possibly resulting from higher wage inflation, and it will be important to see if it has continued to do so (see table below).

                                 Number of Major Core CPI Components 

                                   0.2% or Less                     0.3% or More

Oct                                    7                                         9                                       

Sep                                   9                                         7

Aug                                  13                                        3

July                                    8                                        8

June                                 13                                       3

May                                  11                                       5

Tariffs and Employment

The stock market's rally should not be derailed by this week's key US economic data if consensus-like data print.  Trump's vow to impose tariffs on Canada, Mexico and China will hover over the stock market in coming weeks.    However, for the moment at least, the headlines may not be all bad for the market.

Consensus looks for a benign November Employment Report, showing only a moderate bounce-back in jobs from the adverse effects of October's bad weather and strikes.  Nonfarm Payrolls are seen bouncing back to +183k m/m from +12 in October.  If the adverse effects amounted to about -100k in October, a full bounce back would result in a print over 200k.   So, the consensus estimate implicitly assumes some softness in labor demand outside of these effects.  The Claims data support such assumption, as they hint of weaker hiring more than offsetting fewer layoffs.  With the consensus estimate, the two-month Payroll average is close to 100k -- below the level consistent with a steady Unemployment Rate.  Nevertheless, the Rate is expected to be steady at 4.1%.  Average Hourly Earnings (AHE) could be the most important part of the Report.  Consensus sees a slowdown to the old trend of 0.3% from 0.4% in October.  If AHE does not slow, it would provide more evidence that wage inflation has become problematic.

It's too soon to say whether Trump's announced intention to impose 25% tariffs on Canada and Mexico and 10% on China will have a significant impact on US economic activity or inflation.  The tariffs may be bargaining tools to push these countries to clamp down on drug traffic and immigration to the US.  Presumably, the tariffs will not be implemented if agreement is reached in these areas.  Any news of a start of bi-lateral negotiations between any of these countries and the US will be a market positive.  The Mexican President's promise to stop immigrants from crossing her country and reports of US/Venezuelan discussions move in that direction.        

The direct impact of the tariffs are likely to be less than the stated increases.  Dollar appreciation against these three countries, which has begun already, will offset the inflationary impact.  These countries' currencies have depreciated a lot (the mirror image of the dollar appreciation) over the past few months and will likely depreciate further (see table below).  The timing of the currencies' depreciation is not coincident with the tariffs, but could allow exporters to absorb at least some of the tariffs instead of passing them through to prices.  

There are other potential consequences of the tariffs.  Some production could shift to the US or other countries, with inflationary consequences stemming from higher costs of production and/or greater pressure on labor markets.  The latter could be offset by weaker US exports to these countries, as the stronger dollar make them less competitive with the rest of the world.  On balance, the size of the impact of the tariffs on the US economy is not clear.  Regardless of the impact on the US economy, the stronger dollar lowers the dollar value of profits earned abroad by US companies.

                               Approximate Change in Value Against the US Dollar

                               Canadian Dollar        Mexican Peso        Chinese Yuan

                               -5% since Sept          -23% since May      -4% since Sept