Evaluating Likelihood Of A Fed Rate Decision

The stock market is back to being concerned about the Iran war and tech consolidation.  Nevertheless, the possibility of Fed tightening at some point remains in the background after Fed Chair Warsh downplayed the low June inflation data -- essentially saying one month does not make a trend --  and the real-side data continue to be decent.

The Unemployment Claims data indicate a still firm labor market.   The latest week showed a dip in both Initial and Continuing, although it remains to be seen whether the dips reflected the impact of the July 4th holiday.  If they stay at their lower levels for a couple more weeks, they would point to a speedup in July Nonfarm Payrolls from the +57k in June.   The July Employment Report will be released August 7.

The Claims data may very well be highlighted positively by Warsh's Task Force on improving economic data.  This is because they are not subject to sampling error, being a universal count of all people filing for unemployment insurance -- either for the first time or an additional week.  Moreover, they represent the labor market for the entire economy.  Other economic data --such as Retail Sales, Durable Goods Orders, Industrial Production, Housing Starts -- reflect only a sliver of the economy.  None gives a complete picture.  They are important in providing clues on the areas helping or hurting economic growth, thus helpful for looking ahead, but can distort a picture of the overall economy at the current time by giving only a partial view.

With Warsh suggesting an ending of the Fed's forward guidance, the question becomes how to determine what will push the Fed to raise or lower rates.  Warsh has said the Fed will get clues on how to proceed by looking at the markets if they are allowed to move without being told the Fed's intentions.  One important clue presumably would be longer-term Treasury yields.  If they break above a recent range, particularly if they move up faster than the shorter end of the yield curve, they could be signaling the need for the Fed to tighten.  Conversely, if they break below the recent range, they could point to an easing.  To be sure, longer-term yields can be impacted by a number of factors, some of which should not affect monetary policy.  These include expectations of the Federal Deficit, volatility in the FX market, and other risk factors.  Nevertheless, an upward breakout could reflect higher inflation expectations and vice versa.  

A breakout in Treasury yields would likely have to be of significant magnitude and duration.  The recent history of the 10-year Treasury yield shows this to have been the case.  It rose sharply (about 50 BPs) since the start of the Iran war in February and is now hovering around this elevated level until recently when it has begun to move up again.  The yield curve has begun to steepen again, as well.  Concern about the potential inflationary impact of the renewed US/Iran fighting is likely behind the move up in longer-term yields.  If the high long-term yields continue, they will raise the risk that the Fed may soon hike rates.

 

 

 

 

 

 

 

 

 

 

 

June CPI and Fed Chair Testimony

The stock market may be helped by a couple of developments beginning this week --  possibly a low inflation print and the start of strong corporate earnings.  The market also will face a reminder of the Fed's anti-inflation stance with Fed Chair Warsh's semi-annual Congressional testimony on monetary policy.  However, he is unlikely to provide a clue regarding the July FOMC rate decision.

Consensus looks for a decline in the June Total CPI but a high Core.  It sees -0.1% m/m Total and +0.3% Core.  High prices for World Cup games (as well as for intra-/inter city transportation) and a moderate boost to Airfares from seasonal factors could be behind the high Core estimate.  However, price hikes in some components in May (Tax Preparation, Communication Services) will not likely repeat in June.  And, the drop in energy prices may pull down Total and their pass-through hold down Core by more than consensus expects.  So, downside risk to the consensus estimates can't be ruled out.  Moreover, if Core is boosted by World Cup-related components, the high print could be discounted as temporary.

Fed Chair Warsh gives the semi-annual Monetary Policy Testimony this week.  Typically, the summer testimony reflects the consensus view at the June FOMC Meeting.  So, the latter's Minutes likely offers clues to his testimony.

Warsh will probably continue to emphasize the Fed's anti-inflation focus, as he did at the post-FOMC Meeting news conference.  He also may talk about the many issues regarding the measurement of inflation, mentioning how they will be addressed by his newly created task forces.   Nevertheless, the Minutes indicated what is truly of concern to Fed officials:

"The majority of participants highlighted the possibility that, after several years of inflation above 2 percent, continued elevated inflation rates could begin to affect inflation expectations and wage-and price-setting decisions."  

The m/m decline in the Michigan Survey's 5-year Inflation Expectations to 3.3% in June from 3.9% in May should be a relief for Fed officials, although it does not eliminate their concern since the Expectations remain above the 2.8-3.2% range of 2024..  

They still are concerned about the start of a wage-price spiral.  However, so far, there is no evidence of a wage-price spiral developing from this year's various price shocks.  The Minutes said:

"Many participants remarked that the labor market was not currently a source of inflationary pressures, or that nominal wage growth remained consistent with inflation moving toward 2 percent." 

The absence of a wage-price spiral suggests there is no pressing need for the Fed to tighten.  

However, Warsh is unlikely to hint at the next policy move, particularly since the FOMC members' views were mixed at the June meeting.  The Minutes said;

"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."

Warsh will likely acknowledge the Fed's other mandate regarding the labor market, but indicate it is not a problem for now.  The Minutes said:

"Participants generally expected labor market conditions to remain stable in the near term, with the
unemployment rate staying close to current levels. Some participants remarked that their concerns
earlier this year about labor market deterioration had eased with recent data, and several participants
noted that the solid payroll employment data in recent months could signal increased labor market
momentum." 

"Several participants cited, however, the possibility that uncertainty related to geopolitical
developments or the broader economic outlook could lead firms to reduce hiring or begin
implementing layoffs. Some participants commented on the possibility that AI could, over time, affect
employment prospects for some classes of workers."   

Similarly, Warsh should give a fairly positive description of the current state of the economy.  The Minutes said:

"Participants generally observed that economic activity had continued to expand at a solid pace,
despite elevated uncertainty, supported by strong business investment and resilient consumer
spending."  

On balance, Warsh's testimony will not likely change market perceptions that the balance of risks tilts toward inflation and that the Fed is focused on it.  However, whether or when the Fed will act may remain uncertain.

 

 

 

  

June Employment Not Soft Enough, But Market Relief Ahead

The stock market may continue this week to be concerned about the possibility of a Fed rate hike at the next FOMC Meeting, with the Minutes of the June 16-17 FOMC Meeting the focus.  The Minutes should emphasize the need to bring down inflation, but the market could find relief if they show many participants still expecting inflation to slow on its own.  The market soon may get relief from a couple of other sources.  The Q226 corporate earnings season is expected to be strong.  And, the June CPI, due July 14, may very well be soft.  

The June Employment Report was not likely soft enough to derail the possibility of a Fed rate hike (or a hint of one at a coming meeting) at the July 28-29 FOMC Meeting.  The 59k increase in Nonfarm Payrolls is consistent with population growth, cited by Fed Chair Warsh as a reason to think the labor market is in good shape.  Moreover, the Unemployment Rate fell to 4.2% from 4.3%.  A drop in the Labor Force more than offset lower Civilian Employment.  However, the declines in both may be largely a result of the small sample bias of the Household Survey.  The calculation of the Unemployment Rate eliminates this bias.

A closer look at Payrolls shows a somewhat stronger picture than seen in the headlines.  Excluding the unusual volatility in Leisure and Hospitality jobs, Payrolls would have risen 118k m/m in June after +89k in May (official data: +57k in June after +129k in May).  However, once again job gains were concentrated in only a couple of sectors -- Health and Private Education and Professional and Business Services.  That said, the Report points to modest economic growth ahead.  Total Hours Worked in June were only 0.3% (annualized) above the Q226 average -- a soft take-off point for Q326.  Similar m/m THW gains as in June would put the THW average up 1.0% (q/q, saar) in Q326, versus +1.3% in Q226.  

Corporate earnings are expected to be strong in Q226.  Consensus looks for a whopping 23% y/y increase in S&P 500 corporate earnings.   This is close to the even greater 28.4% growth seen in Q126.  The macroeconomic evidence is mixed, but is positive on balance.  On the downside, Real GDP Growth and European Mfg PMI slowed on a y/y basis from Q126.  Also, the softer dollar provided a smaller boost to earnings abroad than in Q126.  On the positive side, oil company earnings should be helped by higher oil prices by even more than in the prior quarter.  And, profit margins may have expanded, as the Core CPI sped up while Average Hourly Earnings slowed.  

                                                                                                                                        Euro  Area   

                  Real GDP     Oil Prices      Trade-Weighted Dollar    AHE     Core CPI    Mfg PMI  

                     [                y/y percent change                                                            ]          (level)

Q424             2.5               0.0                      +3.5                               4.1           3.4               45.4       

 

 Q125            2.1              -6.5                      +6.0                               4.1           3.1               47.6                                       

Q225            2.0             -16.0                      +3.5                               3.9           2.8               49.3     

 

Q325            2.3              -11.0                      -1.5                               3.9           3.1               50.0  

 

Q425            2.0              -14.0                      -4.0                                3.9           2.6               53.3  

 

Q126            2.7               40.0                       -8.0                               3.6           2.5                50.6     

 

Q226            2.0 *            75.0                       -4.0                               3.5           2.8                51.7                                                                  

                                                                           

* Based on the Atlanta Fed Model's latest projection of 1.2% for Q226 (q/q, saar).

A Soft Enough Employment Report?

The stock market may continue to be pressured by the potential for adverse developments affecting the US-Iran agreement, consolidation in the tech sector, and fear of a Fed rate hike at some point.  Last week's May PCE Deflator data did not allay this fear.  So, this week's June Employment Report contains the next set of evidence that could argue against a rate hike (or at least a hint of one coming) at the July 28-29 FOMC Meeting.  The evidence would presumably have to show a significant softening in labor market conditions to allay market fears.

The softening may have to be broader than a slowing in Nonfarm Payrolls.  Consensus looks for Payrolls to slow to +114k m/m from +172k in May.  The Claims data support a slowdown expectation, as Continuing Claims rose between the May and June Payroll Survey Weeks (see table below, which shows the inverted change between survey weeks).  The consensus estimate, however, is above the 50-60k pace consistent with Population Growth, so jobs would still be growing sufficiently to satisfy Fed Chair Warsh.  He had indicated at his post-FOMC news conference that job growth close to population growth shows a satisfactory labor market.

The Employment Report may need to show both an increase in the Unemployment Rate, perhaps a large increase to 4.5% from 4.3%, as well as soft Average Hourly Earnings to convince Fed officials that a rate hike would be undesirable.  Consensus, however, looks for a steady 4.3% Unemployment Rate and a trend-like 0.3% m/m increase in Average Hourly Earnings in June.    The Insured Unemployment Rate, based on Continuing Claims, does not suggest a significant change in the official Unemployment Rate in June.

The May PCE Deflator remained high, with Total up 0.4% m/m and Core up 0.3%.  The y/y rose for both.  The Trimmed Deflator, Warsh's favorite measure of inflation, worsened, as well (see table below). 

                                Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS    Continuing Claims *        

    April  25             62                          167                            133                               14                            

    May                    37                          140                              69                              -74           

    Jun                    -33                            74                             -27                              -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                               -4                                 2                            

   Sep                    -32                           119                              104                             28 

   Oct                     42                             na                                  1                             -41 

   Nov                   -32                            69                                41                               14

    Dec                   41                            37                                 48                               30     

    Jan 26               22                          172                               146                               94   

   Feb                    63                           -86                              -148                              -14   

   Mar                   62                           186                               202                                 6     

   Apr                  109                          123                                177                               40                

   May                122                           120                                   na                               -9       

   Jun                   98                             na                                     na                             -36              

 * the inverted change in Continuing Claims between Payroll Survey Weeks, 000s  

 

                 Dallas Fed Trimmed PCE Deflator

One-month PCE inflation, annual rate

	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr	26-May
PCE	4.0	4.3	4.9	8.3	5.0	5.5
PCE ex F&E	4.0	5.5	4.8	3.6	3.0	3.9
Trimmed mean	2.2	2.7	2.0	2.9	2.4	2.8

Six-month PCE inflation, annual rate

	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr	26-May
PCE	2.9	3.3	3.6	4.4	4.9	5.3
PCE ex F&E	2.8	3.2	3.6	3.8	3.8	4.1
Trimmed mean	2.1	2.2	2.0	2.2	2.3	2.5

12-month PCE inflation

	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr	26-May
PCE	2.9	2.9	2.9	3.5	3.8	4.1
PCE ex F&E	3.0	3.1	3.0	3.3	3.3	3.4
Trimmed mean	2.4	2.4	2.3	2.4	2.3	2.4

 

 

 

 

 

 

The New Warsh Fed

The stock market should continue to be subject to developments in the Iran war this week.  It also may trade cautiously into the release of the May PCE Deflator on Thursday, now that the new Fed Chair Warsh emphasized the Fed's intent to bring down inflation.  A below-consensus, trend-like print can't be ruled out, which, however, still might not resolve the question whether the Fed will hike rates at the next FOMC Meeting on July 28-29.  Warsh said that the current trend in inflation is too high.

Warsh was adamant that the Fed will bring down inflation, repeating this promise many times at his news conference.  In some sense, his reiterations sounded as if he "protested too much," perhaps because he had to free himself from his earlier message that rates should be lowered.  Jawboning like this could allow the Fed to hold back tightening, ironically.  Indeed,  his emphatic statements have already led to anti-inflation market developments -- a stronger dollar and lower commodity prices.  However, asked why the Fed did not hike at the meeting he suggested the question could be addressed at the July FOMC Meeting.  So, the risk of a rate hike then remains. 

This week's May PCE Deflator will be the last Deflator release before the July FOMC Meeting.  It's possible some Fed officials may get an early look at the June PCE Deflator in time for the Meeting, however.  The June CPI will have been released, as well.

Consensus looks for +0.3% m/m in the Core PCE Deflator for May  The y/y would rise to 3.9% from 3.8%, assuming no revisions to prior months.  The Core needs to average 0.2% m/m from May through December to keep the y/y at 3.8% by year end.  Such a below-consensus print for May can't be ruled out, inasmuch as the May Core CPI already printed 0.2%.  However, a 0.2% print might have to be from a low un-rounded increase (for example, 0.15% -- annualized, 1.8%) to be Fed-friendly.  A 0.1% print would be a market positive.  

It is not clear what measure of the PCE Deflator will be emphasized by the Fed.  Presumably, the Inflation Task Force, one of the five he is establishing, will provide guidance later this year.  Meanwhile, the market may focus on the Trimmed version of the PCE Deflator, which in the past Warsh has said is preferable.  The latest figures show this measure to be close to the Fed's 2% target:

One-month PCE inflation, annual rate

	25-Nov	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr
PCE	2.7	4.0	4.0	4.9	8.3	4.9
PCE ex F&E	2.2	4.0	5.2	4.9	3.6	2.9
Trimmed mean	1.7	2.2	2.6	2.0	2.9	2.5

Six-month PCE inflation, annual rate

	25-Nov	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr
PCE	2.8	2.9	3.2	3.5	4.4	4.8
PCE ex F&E	2.7	2.8	3.2	3.5	3.8	3.8
Trimmed mean	2.3	2.1	2.2	2.0	2.2	2.3

12-month PCE inflation

	25-Nov	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr
PCE	2.8	2.9	2.9	2.9	3.5	3.8
PCE ex F&E	2.8	3.0	3.1	3.0	3.2	3.3
Trimmed mean	2.5	2.4	2.4	2.3	2.4	2.3

Although Warsh said the labor market is on the right track, with job growth matching population growth, the latest Unemployment Claims data hint at some softening.  So far in June, both Initial and Continuing are above their May averages (see table).  They suggest that layoffs have risen and hiring restrained.  If the higher levels are sustained, they would suggest a slowdown in June Payrolls.  This outcome may be a restraining consideration at the next FOMC Meeting.

                                          Latest in June        May Average               

 Initial Claims                      226k                    212k                              

Continuing Claims            1.810 Mn              1.778 Mn             

 

 

 

 

Will the FOMC Tilt The Risks?

The stock market will continue to be impacted by developments in the Iran war this week, with the announced agreement to end the war a positive.  In addition, the market will focus on this week's FOMC Meeting -- the first when the new Chair, Kevin Warsh, will preside.  A key question is whether he convinces the Committee not to include language in the Statement suggesting the risks in the outlook have tilted toward higher inflation and thus to tightening.  Powell had said there was some discussion about doing so at the prior FOMC Meeting.  An unchanged tilt in the outlook risks in the FOMC Statement would likely be a positive for the stock market.

The latest evidence supports a case not to tilt the risks:

The subdued 0.2% m/m Core CPI in May resulted from fairly widespread soft prints.  More than half of the major components posted price changes of 0.2% or less.  So, the modest increase in Core was an accurate depiction of the overall inflation situation.  (The high May PPI, in contrast, was boosted by just a handful of components.)  To be sure, the Core CPI's y/y rose to 2.9% from 2.8% in April.  However, the uptick appears to be caused by a small boost from y/y shifts in seasonality.  The y/y of the seasonally adjusted Core was steady at 2.8%.   

Although higher energy prices continued to boost the Total CPI in May, the decline in oil prices in June points to a more subdued Total in coming months.  Food Prices may be stabilizing, as well.  They rose 0.2% m/m in May, with Food At Home rising only 0.1%.   

An impediment to achieving the Fed's 2% target for inflation is the stickiness in housing rent, particularly the heavily weighted Owner's Equivalent Rent (OER).  It's been running well above 2% (3.3% y/y in May).  This means that other components of the CPI would need to rise by 1.0% or less to achieve the 2% target, unless OER slows sharply.  The economy may need to weaken significantly for such a broad softening in inflation to happen.

The Fed knows this consequence, which is why Powell always pointed to the Core PCE Deflator Excluding Shelter as a better way to measure inflation.  In May, the Core CPI Excluding Shelter rose 0.1%.  Its y/y was 2.4%.  Warsh's favorite inflation measure -- the Trimmed PCE Deflator -- presumably includes OER, but it rose 2.3% on both a 6-month and 12-month basis in April. 

Evidence on labor costs offers a reason to base policy on the low pace of these measures. Labor Costs rose by just over 3.0% (y/y) according to all the major measures.  This pace should be consistent with about 2.0% price inflation, taking account of productivity gains.  

It is questionable whether OER -- which accounts for a quarter of the Total CPI and about a third of Core -- should be included in a policy target.  This is because nobody pays it!  It's an imputed rent, measuring what homeowners would pay if they paid rent.  Moreover, if they did pay rent, they would be paying it to themselves.  It's used in the CPI because it was meant to be an improvement over the prior method of measuring the price of "housing services" to homeowners -- basing it on the mortgage rate and home price.  This prior method had its own problems.  

Regarding the labor market, the Unemployment Claims are beginning to show some softening.  Both Initial and Continuing Claims have inched up in the past few weeks. 

The Meeting will have updates to the Fed's Central Tendency Forecasts.  There could be an upward adjustment to Real GDP Growth and inflation.

                                                Fed Central Tendency Forecasts 

                (Q4/Q4% change except for Unemployment which is the level in Q426) 

                                                      2026              Latest  Actual         

 Real GDP                                  2.2-2.5%              2.5% *         

Unemployment Rate                  4.3-4.5%              4.3%    

PCE Deflator                              2.6-3.1%              3.8%      

Core PCE Deflator                     2.5-2.8%              3.3%

*  H126 average of 1.6% Q126 Real GDP Growth and Atlanta Fed Model Estimate of 3.3% for Q226.

 

 

 

A Supportive Macroeconomic Background Continues

The stock market should continue to be subject to two non-economic factors this week: /1/ a pullback in tech stocks, possibly in anticipation of large IPOs and /2/ developments in the Iran war.  The macroeconomic background remains supportive.  This week's release of the May CPI is expected to show a more subdued Core than in April.  And, the May Employment Report points to moderate economic growth with contained wage inflation.  The latter keeps open the door for Fed policy easing at some point.

Consensus looks for the run-up in oil prices to continue to impact the May CPI.  It expects +0.5% m/m for the Total and 0.3% for Core, which would lift the y/y for both.  The risk is for a higher-than-consensus Total and lower-than-consensus Core.  However, with oil prices having declined in the past week or so, the market will likely dismiss a high Total.  The downside risk to Core comes from /1/ the possibility that Primary and Owners' Equivalent Rent fall back to 0.2% m/m rather than 0.3% after the technical catch-up boosted them to 0.5% in April and /2/ no significant speedup in other components.  The lower print should keep the y/y steady at 2.8%.

The May Employment Report implied no need for the Fed to change monetary policy, but it did not close the door for an easing at some point.  The contained Average Hourly Earnings should encourage Fed officials to expect price inflation to eventually move down toward their 2% target once the oil and tariff shocks dissipate.  And, there may have been less than meets the eye with regard to the jobs growth:    

First, although the Report showed a larger-than-expected +172k m/m increase in Nonfarm Payrolls, the increase was narrowly based.  Only 3 sectors accounted for most of the gain: Leisure and Hospitality (+70k), Health Care and Social Assistance (+47k), and State Non-Education Government (+44k) -- +161k in total.  Most other sectors were little changed.  Second, Private Payrolls slowed for the second month in a row, slowing more between April and May than between March and April (-57k versus -25k).  The large gains in March and April conceivably could be just a post-winter rebound, and the more moderate May increase could be on a path to a trend-like pace.      

                                 Private Payrolls (m/m change, 000s)

                                    Jan     Feb      Mar    Apr    May

                                    180     -148       202     177    120                   

The steady 4.3% Unemployment Rate and trend-like 0.3% m/m Average Hourly Earnings (AHE) support the Fed's view that inflationary pressures are not stemming from the labor market.  The moderate pace of wage gains continued to be fairly widespread.   Eight of thirteen sectors showed AHE up by 0.3% or less, not much different from the nine in April when AHE overall rose 0.2%.  The y/y fell to 3.4% from 3.6%, keeping it line with other measures of labor cost inflation.  

Another Report last week underscored the absence of inflation pressures from the labor market.  Compensation/Hour -- the broadest measure of labor costs -- was revised down sharply for both Q425 and Q126 (see table below).  The downward revisions brought the y/y to 3.3% in Q126.  It was 4.3% in Q425 and 4.9% in Q424.

                 Percent Change

        (q/q, saar) 

Compensation/Hr Unit Labor Costs

Revised  Prelim Revised Prelim

Q126     2.1    3.1     1.8   2.3

Q425    3.7    6.3             2.1   4.6

There was some evidence in the May Employment Report supporting the perception that job search by college graduates is difficult.  Both Labor Force Participation and Employment fell for people with a college degree in May.  The lower Participation could reflect discouragement.   The lower Employment shows weak hiring.  Nevertheless, Participation fell by more than Employment, so the Unemployment Rate for them dipped to 2.7% from 2.8% in April.