The stock market will likely continue moving down sharply into early January, despite NY Fed President Williams' attempt to undo Powell's inflexible portrayal of monetary policy after the FOMC meeting. The partial federal government shutdown may not end quickly. Also, the market probably has to overshoot on the downside before a bottom is put in. Moreover, the most significant factor behind the Q418 plunge in stocks -- concern about a global and US economic slowdown -- may not recede until the Spring. And, if it does, another Fed tightening will likely return to the radar screens. So, any rally then may very well be restrained and short-lived. The macro-economic background may have to be just right -- neither too cold nor too hot -- to keep the Fed on hold.
Market fears of a sharp slowdown in US and global economic growth likely need to subside for stocks to stabilize. Both US and non-US economic data need to point away from recession but not be so strong as to flame fears of further central bank tightening. With sales abroad accounting for about 45% of S&P 500 company revenue, foreign economic growth is almost as important as US growth for these stocks.
The macro background has to be just right to stabilize the stock market without stoking fears of Fed tightening. Immediately ahead, Q119 Real GDP Growth has to be seen above 2.0% (q/q, saar), the Unemployment Rate staying near the current 3.7% level, and Core PCE Deflator inflation remaining below 2.0% (y/y). While it will take several months to get a reliable handle on Q119 GDP Growth, the monthly Unemployment Rate will be available. For the year as a whole, Real GDP Growth near the bottom of the 2.3-2.5% Fed Central Tendency and the Unemployment Rate near the top of the Fed's 3.5-3.7% Central Tendency could keep policy on hold.
A very positive development for stocks would be if GDP Growth is above 2% in 2019 and the Unemployment Rate does not fall. This combination would suggest potential economic growth is higher than the Fed's estimate of 1.8-2.0% -- a very big positive for the profits outlook. There is already reason to think this may be the case. The two main determinants of potential growth -- labor force and productivity growth -- have sped up in the past couple of years. Labor Force is now growing 1.4% (y/y) after trending 1.0%, as the participation rate is no longer trending down. Productivity is growing 1.3%, after trending 1.0% in recent years. Fed officials so far apparently have been reluctant to incorporate these higher rates of growth in their estimate of potential economic growth. It would be a major dovish shift on their part if they do.
Another positive development for stocks would be if wage inflation starts to decelerate while the Unemployment Rate is steady at 3.7% or at least does not speed up if the Rate moves lower. This result would imply a tenuous relationship between the Unemployment Rate and inflation, making a further decline in the Rate less problematical for the Fed. There are several reasons why wage inflation may slow down independently of the Unemployment Rate -- /1/ Increased competition from abroad, as worsening labor market slack pushes down wage rates there; /2/ an ending of the push to boost the minimum wage to $15/hour, as the bulk of the increases may have occurred already; /3/ lower overall inflation, thanks to the drop in oil prices, lifting real wages and taking pressure off the need to increase nominal wages.
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