If the Fed decides not to hike rates at the December 18-19 FOMC Meeting, they have to do so for convincing reasons in order to avoid adverse market reactions. Otherwise, the Treasury market could view the decision as inflationary and sell off -- which could hurt stocks. The decision perhaps has to be based on economic growth and inflation slowing to below the Fed's Central Tendencies.
So far, Q418 Real GDP growth is slowing but not to below the pace implied by the Fed's 2018 Central Tendency. The Atlanta Fed model currently projects 2.5% for Q418 Real GDP Growth, which is above the 2.1% consistent with the low end of the 3.0-3.2% 2018 forecast. It will be important to see if this projection moves down as more data come in ahead of the FOMC Meeting.
Fed officials could rationalize a decision not to hike by tilting US economic risks to the downside, citing softer foreign economic growth and the drop in the stock market. However, not all measures of financial conditions show a tightening. For example, the Chicago Fed's Financial Conditions Index has remained at a low level (implying easy conditions) for the past several weeks. One factor keeping it low could be the plunge in oil prices. The latter should boost consumption of other goods and services and offset the drag from a stock-related wealth effect.
While skipping a hike would boost stocks, there could be some undesirable fall-out in other markets -- unless the skipping is based on solid arguments. The Treasury yield curve could steepen, as longer-term yields build in higher inflation risks. And, the dollar could fall, putting upward pressure on commodity and import prices. All told, the inflation outlook could worsen, raising the odds of more aggressive Fed tightening ahead.
The undesirable fall-out could be mitigated, however, if upcoming US economic data are soft. In particular, a weak November Employment Report and benign October PCE Deflator would make the economic background more compatible for skipping a hike. Also, a reminder by Fed officials that a hike is a "live" possibility at each FOMC Meeting in 2019 could keep market reactions in check.
The evidence is mixed with regard to the November Employment Report, due December 7. The Claims data softened in early November, raising the possibility of a slowdown in Payrolls or an uptick in the Unemployment Rate. Some of the softness, however, could be temporary, related to the California fires having disrupted economic activity there. In contrast, retail jobs could surge if news reports are correct that large retailers hired many people to deliver packages or to assist in store pickups during the holidays. If there is a surge, it risks reversing sharply in January.
Evidence regarding Average Hourly Earnings is mixed. A surge in relatively low-paid retail jobs would hold down AHE for compositional reasons. But, calendar considerations argue for a 0.2-0.3% m/m increase in Average Hourly Earnings, which would put the y/y at 3.1-3.2% versus 3.1% in October.
The October Core PCE Deflator, due November 29, is likely to be benign. It should print 0.2% m/m, based on the CPI. The latter was boosted by a rebound in Used Car Prices, which has a smaller weight in the PCE Deflator. Also, October's flattening in apparel prices is relatively more important and the pickup in Owners' Equivalent Rent relatively less important in the Deflator than in the CPI. The y/y should fall to 1.9% from 2.0% in September.
Sunday, November 25, 2018
Sunday, November 18, 2018
The Trump/Xi Jinping and FOMC Meetings -- Reasons to be Cautious?
There are enough uncertainties regarding the two main upcoming events -- the Trump/Xi Jinping meeting on November 29th and the FOMC Meeting on December 18-19 -- to be cautious about the stock market's near-term outlook.
The market should be helped by growing optimism regarding a resolution of the US/China trade dispute as the November 29th meeting approaches -- unless comments out of Washington suggest otherwise. However, after the meeting, this optimism may fade if the meeting just sets goals for an eventual agreement. Stocks would be especially vulnerable if the second leg of tariffs looks like it will be imposed in January.
Since a 25 BP hike at the December FOMC meeting is highly likely, the question is whether the Fed will change its 2019 rate projection of 3 more hikes, cutting it to, say, 2. This possibility was raised in comments by Fed Vice Chair Clarida and Atlanta Fed President Bostic that the neutral funds rate is close -- seeming to reverse the mid-October comment by Fed Chair Powell that the neutral rate is a long way off. A cut in the Fed's projection of the funds rate in 2020, as well as in 2019 (without a change in the economic projections) would signal a lower neutral rate. -- particularly if it puts the 2020 projection near or at the 2019 level.
It is not clear, however, what rationale Powell would offer if forward guidance changes from 3 hikes to 2. And, the rationale could influence market reactions. If he cites weak growth abroad having tilted economic risks to the downside, stocks might find it troubling that the Fed has shifted toward a bearish US economic outlook. This rationale also would raise doubts about the wisdom of the Fed's decision to hike at the meeting. The latter could be viewed as exacerbating the downside risks to the outlook.
Powell's more recent comment reminding the market that each FOMC meeting will be "live" next year -- as Powell will speak to reporters after each meeting -- fits with the Fed taking a more relaxed approach to tightening and could keep the markets in check. Policy can change quickly if needed. For example, if Fed officials think incoming economic data warrant more aggressive tightening, they do not have to wait until a quarter-end meeting to hike rates. The markets would be more sensitive to US economic data and more restrained ahead of all the FOMC meetings than in the past couple of years. This point would probably be made by Powell in his post-meeting press conference.
The market should be helped by growing optimism regarding a resolution of the US/China trade dispute as the November 29th meeting approaches -- unless comments out of Washington suggest otherwise. However, after the meeting, this optimism may fade if the meeting just sets goals for an eventual agreement. Stocks would be especially vulnerable if the second leg of tariffs looks like it will be imposed in January.
Since a 25 BP hike at the December FOMC meeting is highly likely, the question is whether the Fed will change its 2019 rate projection of 3 more hikes, cutting it to, say, 2. This possibility was raised in comments by Fed Vice Chair Clarida and Atlanta Fed President Bostic that the neutral funds rate is close -- seeming to reverse the mid-October comment by Fed Chair Powell that the neutral rate is a long way off. A cut in the Fed's projection of the funds rate in 2020, as well as in 2019 (without a change in the economic projections) would signal a lower neutral rate. -- particularly if it puts the 2020 projection near or at the 2019 level.
It is not clear, however, what rationale Powell would offer if forward guidance changes from 3 hikes to 2. And, the rationale could influence market reactions. If he cites weak growth abroad having tilted economic risks to the downside, stocks might find it troubling that the Fed has shifted toward a bearish US economic outlook. This rationale also would raise doubts about the wisdom of the Fed's decision to hike at the meeting. The latter could be viewed as exacerbating the downside risks to the outlook.
Powell's more recent comment reminding the market that each FOMC meeting will be "live" next year -- as Powell will speak to reporters after each meeting -- fits with the Fed taking a more relaxed approach to tightening and could keep the markets in check. Policy can change quickly if needed. For example, if Fed officials think incoming economic data warrant more aggressive tightening, they do not have to wait until a quarter-end meeting to hike rates. The markets would be more sensitive to US economic data and more restrained ahead of all the FOMC meetings than in the past couple of years. This point would probably be made by Powell in his post-meeting press conference.
Monday, November 12, 2018
Any Macro Help for Stocks This Week?
The stock market may not get much relief from this week's US economic data or other macroeconomic/political developments.
The US economic data are expected to show a still strong economy with contained inflation. A consensus 0.2% m/m increase in the October Core CPI cannot be ruled out. Used car/truck prices may not fall as much as they did in September. Their 3.0% m/m drop was responsible for the Core CPI rounding down to +0.1% m/m that month. Even if the October Core CPI prints a below-consensus +0.1% m/m, it may not be enough to have more than a transitory effect on the market. Fed officials may have to begin emphasizing a below-2.0% core inflation trend before the market reacts strongly to such prints.
So far, market talk regarding inflation has centered on the speedup in Average Hourly Earnings, a narrow measure of labor costs. There has been little, if any, attention to the more subdued trends in the broader Compensation/Hour and Unit Labor Costs. Fed officials understand they are the best measures of labor costs. Their subdued trends could influence the Fed's forward guidance in a market-positive way at the December FOMC Meeting, even if, as is likely, the funds rate is hiked.
Note that while the newswires made much of Friday's high October PPI print, the underlying component -- Core Ex Trade Services -- was in line with its modest trend. Moreover, the plunge in oil prices should lead to lower airfares and prices of other energy-intensive goods and services in coming months. The plunge also frees up about $200 Bn for consumers (some of which could be offset by lower US oil production and exploration).
The split Congress coming out of the mid-term elections is a potential negative for stocks. If Democrats in the House begin investigations aimed at undermining the Administration, they would likely be seen as a negative. If the two sides cooperate with each other, negotiating legislation to address a variety of issues, the efforts would be good for society. But, if they result in new fiscal stimulus, e.g., infrastructure spending or middle-class tax cuts, the financial markets will feel more pressure to move in ways that crowd out other spending.
Headlines regarding the upcoming Trump/Xi Jinping meeting should continue to provide temporary boosts to the stock market. But, at most, the meeting will probably only result in Trump delaying additional tariffs on Chinese goods in return for continuing discussions and negotiations. A resolution of the US/Chinese dispute will likely take a long time to be achieved. So, the dispute would be put on the back burner by the markets after the meeting.
The global economic slowdown, caused in part by the tariffs and higher dollar, remains an issue for the stock market, particularly as it hurts earnings from abroad. But, the slowdown acts as a drag on US exports, which takes pressure off US markets to crowd out other spending. It also acts to hold down global and US domestic prices, which allows the Fed (and markets) to tolerate faster US real economic growth. So, the market's concern may be overdone.
The US economic data are expected to show a still strong economy with contained inflation. A consensus 0.2% m/m increase in the October Core CPI cannot be ruled out. Used car/truck prices may not fall as much as they did in September. Their 3.0% m/m drop was responsible for the Core CPI rounding down to +0.1% m/m that month. Even if the October Core CPI prints a below-consensus +0.1% m/m, it may not be enough to have more than a transitory effect on the market. Fed officials may have to begin emphasizing a below-2.0% core inflation trend before the market reacts strongly to such prints.
So far, market talk regarding inflation has centered on the speedup in Average Hourly Earnings, a narrow measure of labor costs. There has been little, if any, attention to the more subdued trends in the broader Compensation/Hour and Unit Labor Costs. Fed officials understand they are the best measures of labor costs. Their subdued trends could influence the Fed's forward guidance in a market-positive way at the December FOMC Meeting, even if, as is likely, the funds rate is hiked.
Note that while the newswires made much of Friday's high October PPI print, the underlying component -- Core Ex Trade Services -- was in line with its modest trend. Moreover, the plunge in oil prices should lead to lower airfares and prices of other energy-intensive goods and services in coming months. The plunge also frees up about $200 Bn for consumers (some of which could be offset by lower US oil production and exploration).
The split Congress coming out of the mid-term elections is a potential negative for stocks. If Democrats in the House begin investigations aimed at undermining the Administration, they would likely be seen as a negative. If the two sides cooperate with each other, negotiating legislation to address a variety of issues, the efforts would be good for society. But, if they result in new fiscal stimulus, e.g., infrastructure spending or middle-class tax cuts, the financial markets will feel more pressure to move in ways that crowd out other spending.
Headlines regarding the upcoming Trump/Xi Jinping meeting should continue to provide temporary boosts to the stock market. But, at most, the meeting will probably only result in Trump delaying additional tariffs on Chinese goods in return for continuing discussions and negotiations. A resolution of the US/Chinese dispute will likely take a long time to be achieved. So, the dispute would be put on the back burner by the markets after the meeting.
The global economic slowdown, caused in part by the tariffs and higher dollar, remains an issue for the stock market, particularly as it hurts earnings from abroad. But, the slowdown acts as a drag on US exports, which takes pressure off US markets to crowd out other spending. It also acts to hold down global and US domestic prices, which allows the Fed (and markets) to tolerate faster US real economic growth. So, the market's concern may be overdone.
Sunday, November 4, 2018
This Week's Key Events -- Negative for Stocks?
The stock market may have trouble with the two key events this week -- the midterm elections (Tuesday) and FOMC Meeting (Wednesday-Thursday) -- even if their outcomes match widely-held expectations. While the US economic calendar is light, Monday's October Non-Mfg ISM is likely to fall.
Mid-Term Elections
The conventional view is that a resulting split Congress, with the Democrats controlling the House and Republicans the Senate, would be a mild positive for stocks, based on history. Stocks rallied on a split Congress in the recent past. This past tendency, however, may not play out this time. Two reasons are:
1. A split-Congress was viewed positively by stocks in the past because it would prevent anti-business or re-distribution legislation from being passed. This time, it could prevent passage of pro-business laws. It also could be viewed as hurting Trump's bargaining power in trade negotiations with China and the EU.
2. If the Democrats and Republicans find common ground, such as infrastructure spending as some have reported, this would prompt financial markets to move further to crowd out other spending -- given the economy is operating near full employment. Longer-term yields and dollar would rise and stocks fall.
Even a follow-through of Trump's promise of a post-election executive order to cut middle-income taxes would not likely be a positive for stocks. It also would push the financial markets to crowd out other spending.
FOMC Meeting
There is not likely to be any significant change in the FOMC Statement from what it was in September. It may no longer describe business fixed investment as strong, but that is minor. Nevertheless, the Statement should underscore the Fed's intention to tighten gradually, with no hint of skipping December. Repeating September's language also would accommodate the idea that future rate hikes will be data dependent. With the door still open to the Fed's tightening plans, the markets could be disappointed.
Post Mid-Term Election Rally?
Overall, there may be too much talk of a post mid-term election stock market rally for it to happen as yet. These historical/seasonal patterns have not held in the past 3 months. And, a re-test of the stock market's lows may be needed to dash this talk before a rally is possible. A re-test may happen this week. But, it may be short lived. A low October Core CPI print (due November 14) and firmer positive comments out of the White House regarding the November 29 Trump-Xi Jinping meeting are potential catalysts for a rally.
Mid-Term Elections
The conventional view is that a resulting split Congress, with the Democrats controlling the House and Republicans the Senate, would be a mild positive for stocks, based on history. Stocks rallied on a split Congress in the recent past. This past tendency, however, may not play out this time. Two reasons are:
1. A split-Congress was viewed positively by stocks in the past because it would prevent anti-business or re-distribution legislation from being passed. This time, it could prevent passage of pro-business laws. It also could be viewed as hurting Trump's bargaining power in trade negotiations with China and the EU.
2. If the Democrats and Republicans find common ground, such as infrastructure spending as some have reported, this would prompt financial markets to move further to crowd out other spending -- given the economy is operating near full employment. Longer-term yields and dollar would rise and stocks fall.
Even a follow-through of Trump's promise of a post-election executive order to cut middle-income taxes would not likely be a positive for stocks. It also would push the financial markets to crowd out other spending.
FOMC Meeting
There is not likely to be any significant change in the FOMC Statement from what it was in September. It may no longer describe business fixed investment as strong, but that is minor. Nevertheless, the Statement should underscore the Fed's intention to tighten gradually, with no hint of skipping December. Repeating September's language also would accommodate the idea that future rate hikes will be data dependent. With the door still open to the Fed's tightening plans, the markets could be disappointed.
Post Mid-Term Election Rally?
Overall, there may be too much talk of a post mid-term election stock market rally for it to happen as yet. These historical/seasonal patterns have not held in the past 3 months. And, a re-test of the stock market's lows may be needed to dash this talk before a rally is possible. A re-test may happen this week. But, it may be short lived. A low October Core CPI print (due November 14) and firmer positive comments out of the White House regarding the November 29 Trump-Xi Jinping meeting are potential catalysts for a rally.
Friday, November 2, 2018
October Employment Report Does Not Change the Fed's Issue
The October Employment Report should sustain expectations of a December Fed rate hike. But, the Report does not change the issue faced by the Fed -- economic strength is not translating into significantly higher inflation. Upcoming reports on the October and November CPI remain important with regard to what the Fed does or says at its December FOMC Meeting.
The +250k m/m October Payrolls keeps the 3-month trend in Payrolls above 200k, arguing for additional tightening. But, the jobs strength is pulling people into the labor force, meeting the higher demand for labor and mitigating the pressure on wages. The Labor Force Participation Rate rose in October, keeping the Unemployment Rate steady at 3.7%. Some of the increase could have been sampling noise. Nevertheless, the steadiness in the Participation Rate so far this year runs counter to its demographically-related downtrend -- as Fed Chair Powell keeps pointing out.
The 0.2% m/m increase in October Average Hourly Earnings could have been held down by calendar and composition effects. It is in line with the average m/m pace seen this year. The y/y rose to 3.1% because of base effects -- AHE temporarily fell 0.2% in October 2017. AHE rebounded in November (+0.2%) and December (+0.4%) 2017. But, calendar considerations suggest 0.3% for November and December 2018, which would keep the y/y at 3.1% by year end.
While wage rates have sped up a bit, the broadest measure of labor costs -- Compensation/Hour -- shows a more subdued trend. And, the wage increases may not be inflationary, since a speedup in productivity has slowed Unit Labor Costs.
Labor Cost inflation is slowing, according to its broadest measure. Compensation/Hour has slowed so far this year relative to its 2017 pace. While both years' paces are above the rate of increase in 2016, this year's difference is almost fully offset by stronger productivity. As a result, Unit Labor Costs are up only slightly more than they were in 2016. It is one reason the Core PCE Deflator has risen close to the 2016 pace so far this year. (The Deflator's 2017 slowdown reflected in part a price war in the telephone industry -- margins were cut.)
(percent change over the year)
Compensation/Hour Productivity Unit Labor Costs Core PCE Deflator
2018 * 3.1 1.8 1.2 1.9
2017 3.4 1.1 2.2 1.6
2016 1.1 0.1 0.9 1.8
* over the first 3 quarters, annualized
The +250k m/m October Payrolls keeps the 3-month trend in Payrolls above 200k, arguing for additional tightening. But, the jobs strength is pulling people into the labor force, meeting the higher demand for labor and mitigating the pressure on wages. The Labor Force Participation Rate rose in October, keeping the Unemployment Rate steady at 3.7%. Some of the increase could have been sampling noise. Nevertheless, the steadiness in the Participation Rate so far this year runs counter to its demographically-related downtrend -- as Fed Chair Powell keeps pointing out.
The 0.2% m/m increase in October Average Hourly Earnings could have been held down by calendar and composition effects. It is in line with the average m/m pace seen this year. The y/y rose to 3.1% because of base effects -- AHE temporarily fell 0.2% in October 2017. AHE rebounded in November (+0.2%) and December (+0.4%) 2017. But, calendar considerations suggest 0.3% for November and December 2018, which would keep the y/y at 3.1% by year end.
While wage rates have sped up a bit, the broadest measure of labor costs -- Compensation/Hour -- shows a more subdued trend. And, the wage increases may not be inflationary, since a speedup in productivity has slowed Unit Labor Costs.
Labor Cost inflation is slowing, according to its broadest measure. Compensation/Hour has slowed so far this year relative to its 2017 pace. While both years' paces are above the rate of increase in 2016, this year's difference is almost fully offset by stronger productivity. As a result, Unit Labor Costs are up only slightly more than they were in 2016. It is one reason the Core PCE Deflator has risen close to the 2016 pace so far this year. (The Deflator's 2017 slowdown reflected in part a price war in the telephone industry -- margins were cut.)
(percent change over the year)
Compensation/Hour Productivity Unit Labor Costs Core PCE Deflator
2018 * 3.1 1.8 1.2 1.9
2017 3.4 1.1 2.2 1.6
2016 1.1 0.1 0.9 1.8
* over the first 3 quarters, annualized
Subscribe to:
Posts (Atom)