Amidst Potential Downside Risks, the Fed is Now a Positive for Stocks

Although the stock market may trade cautiously into the Q418 earnings season starting this week, the Fed's shift to a wait-and-see approach to monetary policy is a strong positive for the stock market's H119 outlook.  Even the hawkish Cleveland Fed President Mester says she now favors not tightening until inflation picks up.  While the Claims data so far suggest a modest economic slowdown at most, there is now a "Powell Put" on the economy -- he essentially said the Fed would ease if the economy weakens significantly and inflation remains subdued.  

Powell cited two main downside risks in the outlook for the US economy -- a drag from slower growth abroad and a drag from the volatile financial market conditions.  He downplayed both.   In particular, he believes the recent stimulative fiscal and monetary policies put in place in China will prevent a sharp slowdown there.  He recognizes that the Chinese economic slowdown appears to stem from domestic spending rather than from exports.

My guess is that the Chinese anti-corruption policy has put a damper on conspicuous consumption and income growth there.  In a sense, what is viewed as corruption -- payoffs to corporate and government officials -- can be interpreted as a way to make administered wages/prices closer to market prices.  The payoffs serve to incentivize workers to meet demand.  When they are eliminated, people work and spend less.  Looking at it this way has relevance to the US regarding ideas now being mentioned by some Democrats regarding income re-distribution and steeply progressive tax rates.  They can have disincentive effects.

With political discourse regarding income re-distribution and high top tax rates likely to increase as the 2020 presidential election year approaches, it has to be considered a potential problem for the stock market in H219.  Other potential problems are /1/ a speedup in US economic growth and/or inflation this Spring that could convince the Fed to resume tightening in H219 and /2/ Democratic Congressional investigations/impeachment of Trump.

The Claims data so far do not suggest US economic growth is slowing significantly.  Initial Claims turned down in the first week of January.   Although this is a holiday week, which could impact the data, the w/w decline ran counter to the direction in the first week of January 2018.   Better winter weather this year could be holding them down, which also would be a positive for Q119 Real GDP Growth.  Continuing Claims are still high, but they turned down in the latest week, as well, and may be just lagging. 

                                    Unemployment Claims
                                    Initial               Continuing                    Real GDP Growth
          Q118                  228k                1.904 Mn                         2.2% (q/q, saar)
          Q2                      223                  1.756                               4.2
          Q3                      211                  1.709                               3.4
          Q4                      219                  1.670                               2.8 (e)

           Latest Week      216                  1.722