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.

 

 

 

 

Will Stocks Like A Rate Hike?

The stock market may react positively to a Fed rate hike at this week's FOMC Meeting, while reacting negatively if the Fed does not hike.   The markets raised their probability of a Fed rate hike after the high August Core CPI was released on Friday.  Are they right?  There continue to be mixed considerations.

Possible Stock Market Reaction 

Stocks may view a rate hike positively for several reasons.  /1/ With the Fed finally moving against inflation, longer-term Treasury yields could fall.  The short-end would be taking on some of the anti-inflation work.  /2/ Tighter policy now may reduce the extent of tightening needed later.  /3/ A tighter Fed could reduce the risk premium in commodity prices.  Lower commodity prices, particularly oil, should be a positive for stocks.  It also would work to lower longer-term yields.

In contrast, steady Fed policy could lift inflation expectations and prompt further increases in commodity prices and longer-term yields, both of which would be negative for stocks.  Also, the risk of Fed tightening after the mid-term elections would increase, possibly by more than if the Fed had moved sooner.   So, this risk would continue to weigh on stocks.  And, the markets could conclude that the Fed was bowing to pressure from the Administration, damaging its reputation of being politically independent.  

Arguments For/Against a Hike 

1. While the 0.3% m/m August Core CPI was on the high side, large increases in a couple of components -- Airfares and Lodging Away From Home -- were mainly responsible.  Higher fuel costs were likely behind the jump in Airfares for the second month in row.  Volatility appears to be behind the bounce in Lodging after the latter dropped in July.  The bulk of the Core components were benign.  The Cleveland Fed's measure of the median CPI and trimmed CPI both rose only 0.2% in August.  So, "fence sitter" FOMC members could decide to keep policy steady despite the high print, blaming it on a "bad" distribution of "noise" and higher oil prices this month.  However, they may vote to tighten in response to the stickiness of inflation.  

2.  A desire not to tighten ahead of the midterm elections could hold back the Fed, as well.   

3.  However, the Fed's credibility could be in question if it doesn't tighten, particularly since Warsh has emphasized the Fed's intent to bring down inflation.  He has said that steady but high inflation is not acceptable.  Although the y/y for the Core CPI slipped to 2.4% from 2.5%, it remains above the Fed's 2% target.  The uptick in the University of Michigan Survey's 5-year inflation expectations to 3.4% from 3.3%, reported Friday, could add to the concern that the Fed is losing credibility, as could the recent sharp increase in longer-term Treasury yields.  

4.  Another consideration, away from the latest inflation data, is that the reasons for the 2024-25 rate cuts no longer apply -- /1/ real rates are not higher because inflation fell and /2/ the labor market is not weakening, unlike what appeared to be the case then.  Arguably, reversing these cuts could be appropriate.  This reason would point to another rate hike later this year even if the Fed hiked this week.

5.  In addition, the US economy is being propelled by several independent forces -- AI build-out, defense spending and re-shoring of production.  Higher rates are needed to make room for them, given the economy is at full employment.  Indeed, as Fed officials like to point out, an AI-caused ratcheting up of productivity growth would require higher market yields.  Otherwise, there could be over-investment.

 

 

 

 

 

 

 

 

All Eyes On The CPI

The stock market may trade cautiously into the release of the August PPI and CPI on Thursday and Friday, respectively, after the strong August Employment Report.   The inflation data may be the deciding factor in persuading FOMC "fence sitters" to vote for or against a rate hike.  One fence sitter, Fed Governor Barr, said last week that he may vote for steady policy if the CPI is benign.  

A consensus-like August CPI would not eliminate the possibility of a September rate hike, but it would not guarantee one either.   Consensus looks for a high 0.4% m/m increase in the August Total CPI, boosted by higher oil-related prices resulting from Iran war developments.  A high Total, however, could be dismissed as temporary.  In contrast, a consensus-like Core CPI would point to "sticky" inflation, which Fed Chair Warsh says is unacceptable.  The Core is expected to print 0.2% m/m, which would equal the January-July average and remain above the Fed's 2.0% target on an annualized basis.   The y/y would slip to 2.4% from 2.5% for Core.   The downtick could be viewed positively by the Fed and stock market. 

A lower-than-consensus print for both Total and Core also cannot be ruled out.  Housing Rent (both Primary and Owners' Equivalent) would have to slow from July's 0.3% pace.  And, Airfares need to be flattish to down as would some other typically volatile components like Used Car Prices and Lodging Away From Home.

Fed Chair Warsh, in his Jackson Hole speech, referenced a wide decomposition of the PCE Deflator among his arguments to hike rates (see last week's blog).  A decomposition of the Core CPI by broad components shows most printing 0.2% or less in each of the past three months (see table below).  However, the share was only just above 50% in May and July, when the Core CPI printed 0.2% overall.  So, even though the decomposition differs from Warsh's PCE Deflator figures, it still shows that a broadening slowdown among CPI components is needed to achieve the Fed's inflation target.  It is not clear whether FOMC fence sitters will need to see a broadening slowdown to keep rates steady and not hike rates.  However, a broadening presumably would raise the possibility they will vote to keep policy steady.

                               Number of Broad Core CPI Components                

                             0.2% or less            0.3%        0.4% or more           Core m/m % change

May                            8 (57%)               2                4                                     0.2

June                          11  (79%)              1                2                                      0.0

July                            8   (57%)              1                5                                      0.2

 * number in parentheses is % of the distribution 0.2% or less. 

The August Employment Report confirmed the Fed view of a solid labor market.  Along with upward revisions to June and July, the +162k m/m increase in August Payrolls showed widespread, albeit mostly small, increases among sectors, with notable increases in Manufacturing and Construction.  Payrolls in Leisure and Hospitality had the largest swing, rebounding 62k in August after falling 21k in July (mostly in restaurants).  Excluding Leisure and Hospitality, Private Payrolls rose 65k in August after +92k in July.  These are solid gains in this low job-creation environment. 

The Household Survey confirmed the strength seen in Payrolls.  The Unemployment Rate was steady at a low 4.1%.  The broadest measure -- U-6 -- fell 0.2% point m/m to 7.7%.  Both Civilian Employment and Labor Force rose.  The Labor Force Participation Rate jumped to 61.6% from 61.4%, after having been in a downtrend since November 2025.  The increase could reflect the small sample bias of the Household Survey.  So, an upturn has to be confirmed over the next few months.  However, it raises the possibility that an improving labor market is encouraging people to resume looking for jobs.

Besides the Payroll strength, the 0.1 Hour increase in the Nonfarm Workweek to 34.4 Hours shows better activity in the economy.  Total Hours Worked (THW) rose 0.3% m/m in August, putting it 1.8% (annualized) above the Q226 average.  THW rose 1.2% (q/q, saar) in Q226.

The 0.3% m/m increase in Average Hourly Earnings (AHE) in August supports the Fed's view that the labor market is not producing inflationary pressures.  AHE has averaged 0.3% m/m since the start of 2025.

Trump's call for the Fed to lower the funds rate threw another wrench into the monetary policy debate, doubling down in a sense on Treasury Secretary Bessent's previous announcement of a shift out of long-dated government financing.  Trump's call is puzzling, since it is a widely held belief that Presidential jaw-boning could backfire by pushing Fed officials to act in an opposite way to assert its independence.  Perhaps Trump wants to disassociate himself ahead of the midterms from a tightening decision that may happen this month.  Whatever the motivation, his jaw-boning is not likely to have an impact on the Fed.  Fed officials' views of the economy should be the deciding factors.

 

 

 

 

    

Warsh and Upcoming US Economic Data

The stock market may stay range bound this week, as key US economic data are not expected to change the overall macro picture.  The data are expected to be consistent with the broad outline of the economy described by Fed Chair Warsh at the Jackson Hole Conference last week -- solid labor market and strong manufacturing sector.  Upcoming inflation data could be more important for the Fed.

The Fed's main focus is bringing inflation down to its 2% target, according to Warsh.  He said the Fed will "have work to do" if it does not have confidence that underlying inflation is clearly moving in the right direction and with sufficient speed.  This comment does not guarantee a September rate hike, but suggests upcoming inflation data could trigger one.  The August inflation data will be released September 11 (CPI) and September 30 (PCE Deflator).   The FOMC Meeeting will be on September 16-17.

While Warsh reaffirmed the PCE Deflator as the main measure of inflation for the Fed, he emphasized that the Fed's focus is on the underlying inflation trend -- defined as the "generalized change in prices in the economy, unaffected by idiosyncratic factors."  He mentioned, perhaps for the first time by a Fed official, that more than 50% of the components of the PCE Deflator show increases above 3% over the past 12 months.  The market (and Fed) will likely focus on dis-aggregating upcoming inflation data this way to help judge whether the underlying trend is moving down.  

As for this week's economic data, Warsh reiterated the Fed's view that the labor market is "quite stable and consistent with full employment."  Consensus expects the August Employment Report to fit that description.   Nonfarm Payrolls are seen bouncing back to +45k m/m from -23k in July.  The risk may be for a larger increase, since the July decline reflected a drop in State & Local Government Education jobs that might have resulted from faulty seasonal adjustment.  More importantly, Private Payrolls are seen speeding up to +50k from +30k -- exceeding the prior +40k 3-month average.  (The Claims data suggest little change in the pace of Private Payrolls.)   

Consensus also expects the Unemployment Rate to edge back up to 4.2% from 4.1%, but this would keep it within its low range -- not changing the Fed view that the labor market is at full employment.  And, Average Hourly Earnings is seen speeding up a bit, but to a still below-trend 0.2% m/m from 0.1% in July.  Warsh acknowledged that wage inflation has been "moderate."  But, he did not take much comfort from this, saying that wages have not tended to be a good predictor of future inflation.  

Consensus looks for the August Mfg ISM to edge down to 55.3 from 55.6.  It would remain above the 46.3-53.0 range seen since early 2022.  Such a high level would be consistent with Warsh's view of the manufacturing sector.  He highlighted the strength of capital spending, much of which is tied to the AI build-out.  

Overall, Warsh's speech was essentially one more instance where he identified a problem -- too high inflation -- but did not decisively indicate a near-term rate hike.  Possibly, he does not yet have consensus among FOMC members to tighten policy.  His reference to the somewhat inflationary tilt in the distribution of price increases among PCE Deflator components as well as his sense that financial markets are not restrictive may suggest he is looking for more evidence to convince his colleagues.  Tracking Fed official speeches in coming weeks may offer clues if an absence of consensus in the Committee is the case or is ending.  Hawkish speeches should be expected by the three Committee members who dissented in favor of a hike at the July Meeting -- Cleveland Fed President Hammack (hawk), Minneapolis Fed President Kashkari, and Dalls Fed President Logan,   Fed Governor Waller (fence sitter) speaks on Thursday.  So does President Hammack.

Here is a breakdown of the FOMC Members in terms of hawk, dove and fence sitters, according to AI:

         Hawk                                Dove                Fence Sitter     

    Hammack                            Paulson              Barr           

    Kashkari                                                         Waller               

    Logan                                                              Bowman (slight dove)                                                     

    Warsh                                                             Jefferson       

    Cook (leans)                                                   Williams (slight dove)          

                                                                            Powell 

Fence Sitters would need to be convinced to tighten for there to be a rate hike.

 

   

Soft Macro This Week/Bessent's Attempt

The stock market will likely focus on corporate earnings and Iran developments this week.  It also will face evidence on three macroeconomic items -- the Fed's targeted inflation rate (PCE Deflator), consumer spending and Fed Chair Warsh's Jackson Hole Speech.  Their impacts on the market may be muted as they will not likely change the overall picture of subdued inflation, soft consumption and steady Fed monetary policy.  

Consensus looks for a slight speedup in the PCE Deflator in July from the June pace.  It sees Total up 0.1% m/m after -0.1% in June.  Core PCE Deflator is expected to rise 0.2% after +0.1% in June.  The risk is for a lower-than-consensus print, based on a smaller weight given to housing rent in the Deflator than in the CPI (where it was +0.3% in July), more weight given to apparel (which was +0.1% in July), and an offset to the +2.2% m/m airfares in the CPI with the -3.4% in the PPI.   The consensus estimate of the y/y for the Core PCE Deflator is a steady 3.3%.  The risk is for 3.2%.

Consensus expects a slowdown in Consumer Spending to +0.2% m/m in July from +0.3% in June, reflecting the drag from July Retail Sales reported last week.  Consumer Spending would still be up in real terms if the consensus 0.1% estimate of the PCE Deflator prints.  Even so, downward revisions to May and June Retail Sales are a factor behind the consensus estimate of a large downward revision in Q226 Real GDP Growth to 1.5% (q/q, saar) from 2.1%.  However, there is more to the overall economic picture than just consumption.  Strong business investment is expected to be seen in increases in July Durable Goods Orders and its major components.

BLS will announce its estimate of the Benchmark Revision to Nonfarm Payrolls.  The benchmark is based on a universal count (derived from unemployment insurance data) as of March 2026 and incorporated in the January 2027 Payroll figure released next February.  Some analysts look for a modest downward revision, which would likely be a non-event since it would be well within the historical range.  Benchmark revisions were downward in 7 of the past 10 years, ranging from -1k  to -898k (average -298k).  It was a huge -898k in March 2025.  Upward revisions ranged from +138k to +568k (average +360k). 

Fed Chair Warsh is likely to reiterate that economic growth is solid, labor market steady and inflation still too high -- and that the Fed is adamant to seeing the latter come down.  However, he also should stick to his plan to not specify future monetary policy or project the future path of the economy.  Instead, he may discuss the Task Forces that he has set up to evaluate Fed communications, Fed balance sheet, economic data, productivity and jobs, and inflation targets.  At this point, Warsh has said the Fed's Central Tendency Forecasts will not likely be published after this year.  Discussing these Task Forces will probably be academic and market neutral.

The so-far failed attempt by Treasury Secretary Bessent to lower longer-term Treasury yields by shifting Federal Government financing to the short end is reminiscent of the academic debate that, I believe, began in the 1970s.  The Yale school of thought,  pushed by Jim Tobin, argued that relative supply of longer-term Treasuries (relative to supply of  short-term Treasuries) affects their yield.  The MIT-Penn school of thought, pushed by Franco Modigliani and Albert Ando, argued that expectations of future short-term rates and inflation were the dominant determinants, not relative supply.  Work that another economist and I did at the NY Fed showed that expectations of the Federal deficit and the volatility of the dollar against major currencies in the FX market also had an influence on longer-term yields, besides short-term rate and inflation expectations.  The quick reversal of the dip in longer-term yields from Bessent's announcement would seem to support the MIT-Penn school of thought.  Similarly, my impression at the time was that Fed Chair Ben Bernanke's QE  (quantitative easing: Fed buying longer-term Treasuries) had more effect on the stock market than longer-term yields.   

Although the high Federal Government debt (hitting $40 Tn) received a lot of attention, the renewed increase in oil prices, with the risk that the Iran war will push them up further, may be the more significant factor behind the latest run-up in longer-term yields as it lifts inflation expectations.  Moreover, with the Fed so far reluctant to raise the funds rate, expectations of future rate hikes may have risen, as well.  Another way of putting this is that with Fed policy steady, the burden of fighting inflation falls more on future policy and thus longer-term yields.

  

US Data More Mixed Than Appears

The stock market may be range bound this week, as it focuses on the implications of recent US economic data for Fed monetary policy.  The data were more mixed than market commentators appeared to acknowledge and argue for steady Fed policy.  The July inflation data were ostensibly soft, but some aspects were troubling.  July Retail Sales were weak, but early estimates of Q326 Real GDP Growth remain strong.  These data printed after the July FOMC Meeting, so this week's release of the Minutes will not reflect this new information.  The next opportunity to get a sense of Fed thinking will be Fed Chair Warsh's speech at the Jackson Hole Symposium on August 27-29.  However, he already has said that he may focus on his Task Forces rather than future monetary policy.   He, of course, will emphasize the Fed's goal to bring inflation down.

The July CPI headlines (0.1% m/m Total and 0.2% Core) seem to confirm a slowing inflation trend, as the y/y slipped for both.  But, some components remain worrisome.  In particular, Primary Rent and Owners' Equivalent Rent both sped up to the old 0.3% trend (3.6% annualized).  It will be difficult to hit the Fed's 2% inflation target on a sustained basis if rent doesn't slow to a 0.2% or lower m/m trend.  Also, computer prices rose sharply both in the CPI and PPI, likely resulting from memory chip shortages.  Fed officials have mentioned the impact of AI investment on some prices as one factor making it difficult to hit their target.   This factor should be temporary, disappearing as the memory shortage is resolved.  However, the latter could take time.

The July PPI headlines (0.0% m/m Total and 0.2% Core) understated the underlying pace.  The underlying Core Less Trade Service rose 0.4% m/m (about 5.0% annualized) -- the same high pace as the H126 average and well above what would be consistent with the Fed's 2% target.  

Although July Retail Sales fell, the decline could be just the typical pause after a string of strong months.  It also could be just a one-off unwinding of the boost to sales from  tax refunds in the Spring.  Nevertheless, a slowdown in consumption would not be inconsistent with the slowdown in job growth over June and July.  The Atlanta Fed model lowered its forecast of Q326 Real GDP Growth to 4.3% (q/q, saar) from 4.8%, but it is still well above trend.  The model estimates that consumption will grow 2.5% in Q326 -- which would require a bounce-back in Retail Sales in August and September -- and that other components of GDP will grow, as well.

Although the July FOMC Minutes will not reflect these latest data, the markets will likely look for clues on participants' views of the likely path of monetary policy.  The Minutes of the June Meeting indicated a fairly even split between those expecting steady to slightly easier policy and those expecting tighter policy by year end:

   "Regarding participants’ individual assessments of appropriate monetary policy under what each participant judged to be the most likely scenario for the economy, many participants indicated that the
appropriate level of the federal funds rate would be within or slightly below the current target range at
the end of this year. Many other participants, however, assessed that the appropriate level of the
federal funds rate would be above the current target range at the end of this year."    

The July Minutes could indicate a shift toward the tighter policy group, given that there were three dissents that favored a rate hike at the Meeting.  The markets should be cautious taking such a shift at face value, since some of the hawks could have pulled back their expectations of the year-end funds rate after the latest economic data.

 

 

 

                                                                  

                          

 

 

Macroeconomic Evidence Turning Benign For The Fed?

The stock market may be helped by soft inflation data this week.  Along with Friday's soft July Employment Report, they would argue for steady Fed policy at the September FOMC Meeting. 

Consensus looks for +0.1% m/m Total and +0.2% Core for the July CPI.  The y/y would fall to 3.3% from 3.5% for Total and to 2.5% from 2.6% for Core.  Moreover, lower-than-consensus prints for Total and Core can't be ruled out.  Owners' Equivalent Rent would need to stay low.  Lodging Away From Home needs not to rebound after falling in June, and Airfares need to stay low despite a boost from seasonal factors.  Retail Gasoline Prices should fall again, despite the renewed Iran war.

The July Employment Report showed a soft labor market, possibly reflecting the impact of AI on jobs.  Besides the decline in Payrolls, there appears to be a continuing amount of discouragement to look for jobs.  So, while the Unemployment Rate fell, it may overstate the strength of the labor market.  Indeed, the slight uptick in Average Hourly Earnings also hinted at a soft labor market.

The -20k m/m drop in Nonfarm Payrolls was concentrated in State and Local Government Education jobs (-50k), likely temporary and related to the end of the school year.  More importantly, the below-trend 30k increase in Private Payrolls -- the second such modest gain in a row, both less than half the 80k 3-month average ending in June --  reflected a sharp slowdown in Service-type sectors -- possibly sectors in which implementation of AI is concentrated.  Private Service-Providing Payrolls rose only 5k, after +16k in June.  Both months were substantially weaker than the prior trend.  Cyclical sectors (manufacturing and construction), in contrast, continued to climb.

At this point, it is possible a productivity jump may offset the weak job growth -- consistent with a boost from AI.  With  the Nonfarm Workweek flat and Total Hours Worked up only slightly, the latter stands just 0.1% (annualized) above the Q226 average.  Productivity should be strong in Q326 if the Atlanta Fed Model's early estimate of 5.8% (q/q, saar) for Q326 Real GDP Growth is right.  A productivity jump would support the idea of substitution of AI for labor being responsible for the weakness in job growth.

The dip in the Unemployment Rate to 4.1% fro 4.2% in June may overstate labor market strength to the extent it resulted from people dropping out of the labor force.  The Labor Force Participation Rate has trended down since a peak of 62.5% in November 2025.  This downtrend continued in July, as it slipped 0.1% point m/m to 61.4%.  The downtrend looks to be more than just the effect of the small Household Survey or fully explained by an aging population in which older people are less inclined to work than younger people.

Although it is too soon to say that the soft 0.1% m/m increase in Average Hourly Earnings (AHE) is the new normal, it opens the door to this possibility.  The slowdown from a 0.3% m/m trend was widespread.  10 of 13 major sectors slowed from June and 9 were slower than their Q325 average. Along with the soft Q226 Compensation/Hour and Unit Labor Costs (2.7% and 1.3% (q/q, saar), respectively) reported last week, July AHE is good news for the inflation outlook.