Are Recent Economic Trends Good Enough for the Fed?

The stock market rally should remain intact if consensus estimates of this week's key US economic data are correct.  They would ratify a slowdown and support expectations of Fed rate cuts in 2024.  However, stronger-than-consensus prints for some, such as December Payrolls, are the risk, which could dent the market rally.   A potential problem ahead is that an economic slowdown will not be sufficiently weak to convince the Fed to cut rates in 2024.  However, it is too soon for this issue to be resolved, so the Fed's forecasts of rate cuts in 2024 should still dominate thinking.  

A way to evaluate upcoming economic data in the context of the Fed's Central Tendency forecasts is to compare the data with their recent trends, which at the moment could be considered consistent with the slightly above-trend 2.3% Q423 Real GDP forecast of the Atlanta Fed model.  If so, the data have to weaken relative to these trends to pull GDP growth closer to the Fed's expectation of sub-trend GDP growth in 2024.  

As you can see from the table below, consensus estimates of this week's US economic data are mixed relative to the recent trend.  Job Openings, ADP Estimate, Markit US Mfg PMI and Total Nonfarm Payrolls are expected to soften relative to trend.  In contrast, Construction Spending (for November), Private Payrolls, and Non-Mfg ISM are forecast to be slightly stronger than their recent trend.  So, consensus-like prints shouldn't close the door either way regarding slow-enough economic growth in 2024.

The most important are the labor market indicators.  The expected payroll gain -- both Total and Private -- is still too high relative to the Fed's sub-trend 2024 forecast.  It needs to be sub-100k.  Also, the Unemployment Rate would need to break above its recent range (3.7-3.9%).  So, consensus prints would indicate the Fed is not yet getting what it wants in the labor market. 

A technical change in the January Employment Report, due early February,  could have a bearing on the Fed's view of the economic outlook.  In the January Report, BLS will incorporate revisions to the measurement of the US population.  An upward revision would lift the Labor Force and presumably its growth rate.  The latter could boost the Fed's estimate of the longer-run trend in GDP growth, assuming a higher labor force growth is not offset by lower productivity growth.  A higher trend would allow the Fed to tolerate faster economic growth with less fear of boosting inflation.  The only technical change in the December Employment Report is for revised seasonal factors in the Household Survey.  These typically do not change the Unemployment Rate.

The evidence regarding the December Employment Report is mixed:

1.  Upside Risk to Payrolls:  As mentioned in last week's blog, Initial Unemployment Claims fell modestly since the November Payroll Survey Week, indicating a slight decline in layoffs, while Continuing Claims have stabilized if not dipped from their levels around the November Week.   Both suggest a speedup in Payrolls from November's pace. 

2. Upside Risk to Unemployment Rate: The Claims data, however, also suggest the Unemployment Rate may rebound after falling sharply in November -- and a 3.9% print can't be ruled out.  But, the Claims data are not a reliable predictor of the Unemployment Rate.  

3.  Upside Risk to Average Hourly Earnings: Some lagged boost from the UAW contract is conceivable.  Also, if seasonal factors look to offset softer wage rates of holiday-related temps, the factors may boost them too much if stores hired fewer-than-normal temps this year. 

There is no reliable evidence for the Mfg and Non-Mfg ISMs.  Nonetheless, some surveys suggest a dip in the Mfg ISM -- Markit US Mfg PMI, Chicago PM and Phil Fed Mfg Index.  Evidence is mixed for the Non-Mfg ISM  -- Markit US Services PMI up, Chicago PM down.

                                                         Consensus Estimate        Oct-Nov Avg

Construction Spending                             0.5%                            0.4% m/m

Job Openings                                              8.8 Mn                         9.0 Mn 

ADP Estimate                                            100k                             108k m/m                   

Markit US Mfg PMI                                 48.2                                50.1

Mfg ISM                                                   47.1                                46.7

Nonfarm Payrolls                                     158k                                175k m/m      

Private Payrolls                                         120k                               118k  m/m      

Unemployment Rate                                  3.8%                              3.8%                

Average Hourly Earnings                          0.3%                               0.3% m/m

Non-Mfg ISM                                           52.5                                52.3

RIsk To Stock Market Rally in Early January?

The stock market should continue to climb into year end, before some consolidation in early January is reasonable to expect.  The latest economic data should support the market rally immediately ahead.  They point to slower growth and inflation.  They even suggest the Fed's 2% inflation target is being met.   But, with the market having run up so much and possibly overshot fundamentals, it is vulnerable to a pullback at some point.  In early January, the risk is that a stronger December Employment Report triggers some profit taking.

Last weeks' November Personal Income Report pointed to both slower consumption growth and inflation.  Real Consumption in November was 2.5% (annualized) above the Q323 average, compared with the 3.1% q/q pace in Q323.  The pace is below the prior estimate in the Atlanta Fed model's forecast of Q423 Real GDP Growth.  The latter was revised down to 2.3% from 2.7% as a result.  Meanwhile, the PCE Deflator, both Total and Core, is running close to the Fed's 2% target on a 6-month basis.  The 6-month annualized change is 2.0% for Total and 1.9% for Core.

The lower Atlanta Fed model's projection, however, still suggests economic growth may be faster than desired by the Fed, as it is above the Fed's Central Tendency 1.2-1.7% Real GDP Growth forecast for 2024.  A continuation of solid growth next year could dissuade the Fed from cutting rates.  The next important piece of evidence with this in mind will be the December Employment Report (due January 5).

Early evidence suggests the Report could be problematic.  The Claims data so far suggest the December Nonfarm Payrolls may speed up (excluding strikers).  Initial Claims averaged 211k over the 4 weeks ended in the December Payroll Survey Week, versus 221k ending in the November Survey Week.  They indicate that layoffs have fallen.  So far, Continuing Claims are down slightly since the November Survey Week.  However, Continuing Claims don't rule out the possibility of  rebound in the Unemployment Rate after November's surprising decline to 3.7%.  The Rate may have to rebound to at least the most recent high of 3.9% to prevent being dismissed as "noise."

This week's calendar of US economic data is light.  House Prices and Chicago PM should be of only modest interest to the markets.  The Unemployment Claims data will be the most important. 

Betting On The Fed's Forecasts

The stock market should continue to trade up in the last two weeks of December, sustained by the more balanced stance of Fed policy mentioned by Fed Chair Powell in his post-FOMC news conference.  He said the Fed was now weighting growth and inflation more evenly in its set of goals.  However, the markets' focus on the Fed's forecasts of rate cuts in 2024 risks being disappointed.  Stronger US economic data could be the factor that sparks a stock market correction early next year.

The Fed's Central Tendency Forecasts include 2-4 25 BP rate cuts next year.  Although Powell continues to insist these forecasts are not cast in stone and should not be viewed as necessarily indicative of the actual path of policy, they are important for two reasons.  First, they influence the markets' expectations of future monetary policy, so in a sense they are an additional policy tool to the actual changes in the funds rate.  Second, the overall Central Tendency Forecasts put future rate decisions in the context of expected economic growth and inflation.  They indicate what combination of them would be compatible with the Central Tendency rate forecasts.

The Central Tendency forecasts are for slow economic growth, higher unemployment and lower inflation next year:

                                                 2024            2023

Real GDP Growth *                1.2-1.7        2.5-2.7

Unemployment Rate **           4.0-4.2        3.8

PCE Deflator  *                       2.2-2.5        2.7-2.9   

Core PCE Deflator *               2.4-2.7        3.2-3.3

* Q4/Q4 percent change

**   Q4 Level

In other words, next year's Real GDP Growth needs to slow to a pace below the Fed's 1.7-2.0% estimate of longer-run trend and result in an increase in the Unemployment Rate.  At the same time, inflation has to slow by about 0.5% pt on a y/y basis.  The Real GDP Growth forecast could be difficult to achieve.  Ironically, the markets' anticipation of this expectation may prevent it from happening, as the drop in longer-term yields, higher stock market and weaker dollar all work to stimulate aggregate demand.  Moreover, the Bideneconomic thrust from defense restocking, alternative energy investments and re-shoring of manufacturing from abroad remains largely in force -- to be sure, the auto companies' retrenchment of EV production helps curtail the thrust of the Administration's policy.  Finally, the economy still has good momentum.  The Atlanta Fed models' forecast of Q423 Real GDP Growth was revised up sharply to 2.6% from 1.2% after last week's data releases.  Overall, the Fed's forecast for 2024 may not work out.

Even if the forecast for slow economic growth turns out to be wrong,  one factor may serve to lower inflation.  If housing rent, particularly the measure of Owner's Equivalent Rent, slows to 0.2% m/m from its current trend of 0.5%, the Fed's 2% inflation target may be met.  Since the CPI's measure of housing rent lags actual rent by 6 months or so, it conceivably may slow sharply during H124 as it catches up to the flattening already seen in private surveys of housing rent.  Also, the decline in longer-term yields may help hold down rents -- lower yields encourage new residential construction, thereby lifting the supply of housing.  The issue could become whether the Fed will cut rates with inflation in check even though economic growth remains robust. 

Based on this analysis, weak US economic data should not be a problem for the stock market, as they would reinforce expectations of Fed policy easing ahead.  Economic weakness would be viewed as temporary.  Strong US economic data, however, would be a problem if they raise doubt about rate cuts in 2024.  And, if they are so strong as to suggest the Fed will renew tightening, they would be a significant problem for stocks.  Not only would yields be higher, but the economic strength would be viewed as temporary.

Much of this week's US economic data are housing related.  Consensus expects them to weaken slightly.  Soft prints most likely will be ignored, given the latest drop in yields.  The Purchase Component of Mortgage Applications could begin to get market attention instead.    

Stock Rally Should Survive This Week's FOMC Meeting

The stock market rally should survive this week's FOMC Meeting.  The Fed is likely to keep steady policy and retain its message that further tightening is possible if the trends in economic growth and inflation speed up.   Consensus estimates of this week's key US economic data may underscore this message, although a friendlier Core CPI can't be ruled out.

The November Employment Report did not contain evidence that would persuade the Fed to change its stance.  Excluding the direct effects of strikers, Private Payrolls (Total less Government jobs) rose 112k, a bit slower than the 115k increase in October.  Both increases are in line with estimates of job gains that are consistent with trend economic growth.  Although the Household Survey showed jumps in both Civilian Employment and Labor Force, these figures likely reflect the small sample bias of this Survey.  This bias is eliminated in the calculation of the Unemployment Rate.  And, while the Rate fell to 3.7% from 3.9%, it equals the August-September average.  A steady Rate also is consistent with trend-like economic growth.  Total Hours Worked are on track for 1.0-2.0% Real GDP Growth in Q423.  The Atlanta Fed model's latest projection is 1.2%.

Wage inflation was a bit on the high side in November, with Average Hourly Earnings up 0.4% m/m. But rounding made it look worse than what it was.  The unrounded increase is 0.35%.  Also, the one-off UAW settlement may have added a bit to AHE this month.  The 2- and 3-month averages of AHE are both 0.3%, which is consistent with the Fed's 2% inflation target, taking account of productivity growth.  However, it could be disconcerting to the Fed that moderation in wage inflation is not widespread among sectors.  AHE rose 0.3% or less in only about half of the major sectors.  The absence of a widespread acceptable pace of wage gains argues for the Fed to keep a hawkish tilt in its rhetoric.

The Fed's Central Tendencies will be updated at this meeting.  They are likely to show faster Real GDP Growth, lower PCE and Core PCE Deflator inflation, and no change in the Unemployment Rate forecasts than those made in September.  These changes would be stock market friendly.  The Fed's forecast of rate cuts in 2024 and 2025 will probably not change much, if at all.

Consensus estimates for this week's key November US economic data, however, are somewhat unfriendly.  It looks for 0.0% m/m Total (a good print) but +0.3% Core CPI (slightly higher than desired). A 0.2% print for Core can't be ruled out, but it likely would require substantial holiday discounting and a slowdown in Owners' Equivalent Rent.  Heavy discounting may be behind the consensus estimate of -0.1% m/m  for both Total and Ex Auto Retail Sales.  If so, the soft prints would understate the "real" gains in consumption.  Consensus expects a 0.3% m/m increase in Industrial Production, including a 0.5% rebound in Manufacturing Output.  They reflect the end of the UAW strike, so overstate trend. 

Stocks Uptrend Intact

The stock market should stay in an uptrend, as this week's key US economic data are not expected to change the macroeconomic picture of slower growth/inflation and its implication for steady Fed policy ahead.  

Consensus looks for another sub-200k m/m increase in Nonfarm Payrolls for November.  Total is seen up 170k and Private up 131k.  These estimates include 38k net returning strikers (returning less new strikers), so the underlying pace is even weaker -- 132k Total and 93k Private.  And, they show a slowdown from October's data excluding strikers of +180k and +129k, respectively.  The Unemployment Rate is expected to be steady at 3.9%.  

Evidence from the Claims data point to a slowdown in Payroll growth as well as an uptick in the Unemployment Rate, although questions about their reliability in this holiday season suggest caution in relying on them.  Layoffs appear to have picked up in November, as Initial Claims were 221k in the four weeks ending in the Payroll Survey Week, versus 206k in October.  And, it may have become harder to be rehired, as Continuing Claims rose 144k in November versus 118k in October.  The Insured Unemployment Rate rose by 0.1% point in November, as it did in October -- when the Civilian Unemployment Rate rose to 3.9% from 3.8%.

Consensus looks for a slight speedup in Average Hourly Earnings to +0.3% m/m from +0.2% in October.  This higher pace is still below the +0.4% trend seen earlier in the year.  And, it is consistent with the Fed's 2% inflation target after taking account of productivity growth.  An uptick could result from the new UAW contract.

A recession does not seem imminent, however, despite the increase in Unemployment Claims.  Consumer Spending appears to be holding up, although slowing.  October Consumer Spending set the stage for 2+% (q/q, saar) consumption growth in Q423.  And, reports of holiday sales in November were strong.  Housing demand may have responded already to the pullback in longer-term yields, as mortgage applications have moved up steadily since making a low in late October.  The Atlanta Fed model's latest estimate of Q423 Real GDP Growth is 1.8%.  This pace is in line with the Fed's estimate of longer-run growth and not weak enough to argue for monetary policy easing.

Indeed, the rallies in the stock and Treasury markets, as well as the weakening in the dollar in the FX market, could be laying the groundwork for a speedup in economic growth in H124.  They essentially act as "built-in" stabilizers.  In addition, spending on defense, alternative energy and re-shoring of manufacturing should continue to provide forward thrust to the economy in the background.  A growth speedup could be problematic for the Fed, particularly if there is not much slack in the labor market.   This possibility could become the most consequential downside risk for the stock market ahead.