Problems For Stocks, Despite Positive Fed

The stock market may continue to be weighed down by the Israel-Hamas war and the failure to elect a House Speaker.  These problems could persist for awhile.  Ironically, Fedspeak was market-positive last week, with many officials supporting a further pause in rate hikes.  

A ratcheting up of the Israel-Hamas war looks imminent, according to news reports.  This will probably result in contentious news headlines.  They, regardless of fact, could make the market nervous, as did last week's hospital explosion.  Moreover, the Israeli goal of toppling Hamas will likely take time to accomplish.  So, the risks of escalation could remain an issue for the market.  Alternatively, any movement toward a cease-fire would be a market positive.

The failure of the House to elect a Speaker also is a problem for the stock market.  The market does not like a dysfunctional government in Washington.  The market still may not like it if a Republican hardliner is eventually elected.  He could force a government shutdown in mid-November by insisting on spending cuts to pass a budget.  Instead, election of a moderate Republican could provide relief for the market.

In contrast to these developments, last week's speeches by Fed officials had a positive message for the stock market -- the Fed is willing to wait to see if inflation falls further before deciding whether additional rate hikes are necessary.  Powell's message was the most interesting.  He essentially said the Fed would tolerate strong economic growth if inflation continues to fall, although he acknowledged that history suggests below-trend growth and a looser labor market are needed for the latter.  He is counting on an "unwinding of pandemic-related distortions to supply and demand" and the tighter monetary policy to date to bring inflation down.

This week's release of the September PCE Deflator acquires even more importance after this speech.  Consensus expects +0.3% m/m for both Total and Core.  These estimates look reasonable.  They should result in a decline in the y/y inflation rates, although revisions to past months could affect the y/y, as well.  Powell mentioned that the y/y is expected to be 3.5% for Total, the same as in August (this assumes 0.4% m/m for September Total), and to fall to 3.7% from 3.9% for Core (this assumes 0.3% for September Core).  Looking ahead, Total needs to rise by less than 0.3% m/m and Core by less than 0.5% m/m on average over Q423 to fall further.  Early evidence suggests this may be the case in October.

An expectation of slower inflation could mitigate the market impact of the strong print expected for Q323 Real GDP Growth.   Consensus looks for +4.1% (q/q, saar), while the Atlanta Fed model projects 5.4%.  A high print could be viewed as "history," also mitigating its market impact.

Indeed, early evidence suggests the October Employment Report will show a slowdown in Nonfarm Payrolls (even excluding strikers, who should subtract from Payrolls this month) and possibly an uptick in the Unemployment Rate (unaffected directly by strikers).  The latest Unemployment Claims data suggest hiring has slowed more than layoffs.  Lower inflation and a looser labor market should reinforce expectations of steady Fed policy through year end.