Stock Market Rally On

The stock market rally now looks like it can continue well past this week's FOMC meeting.  Inflation may have attained the Fed's 2% target and economic growth looks solid.  The Fed can become patient, remaining market supportive by making rate cuts still a possibility for H224.  Indeed, Fed Chair Powell may continue to argue that "real" interest rates may become too restrictive as a result of the slower inflation.  With a patient Fed in the background, stocks may take the January Employment Report in stride, particularly if, as the latest evidence suggests, job growth slowed. 

The December Personal Income Report had good news for both the inflation and economic growth outlooks.  PCE Deflators were even lower than their 0.2% m/m  headlines.  Total and Core each rose 0.17% unrounded or up 2.0% annualized.   And, Real Consumption in December was 2.0% (annualized) above the Q423 average -- a strong take-off point for Q124.  Consumption should continue at a good pace in Q124, even if there is some pullback in one or two months as is typically the case after a strong month.

The latest Unemployment Claims data, which include the Payroll Survey Week for Continuing Claims, now support the consensus expectation of a slowdown in January Nonfarm Payrolls.  Consensus looks for Payrolls to slow to +178k from +216k in December.  It also looks for an uptick in the Unemployment Rate to 3.8% from 3.7% and for Average Hourly Earnings (AHE) to slow to 0.3% m/m from 0.4%.  These would be market friendly prints.  Unfortunately, there is no reliable evidence for them. 

The consensus Payroll estimate is likely still too high from the Fed's perspective.   Job growth of 100k or less per month would be more consistent with creating slack in the labor market.  However, this month's Payrolls will incorporate benchmark revisions, which should lower the underlying trend in job growth by about 25-30k per month.  The Bureau of Labor Statistics published its estimate of the benchmark revisions a few months ago.  It estimated a downward revision of 306k (-358k excluding government jobs) in the level of Payrolls in March 2023.   This level adjustment should translate into a lower underlying m/m trend in the months after March 2023 of 25-30k.  The risk is that the headlines for Nonfarm Payrolls will be lower than consensus as a result.

There are several other important US economic data release this week regarding inflation.  Consensus looks for 1.0% (q/q) increase in the Employment Cost Index in Q423, slightly slower than the 1.1% in Q323.  There may be downside risk to the consensus estimate, reflecting smaller bonuses and sales commissions  Consensus also looks for small increases in Compensation/Hour and Unit Labor Costs in Q423.  Perhaps even more important is the expectation of a good-sized 2.4% (q/q, saar) increase in Q324 Nonfarm Productivity.  This would be the third quarter in a row when productivity growth exceeded the 1.0-1.5% typically-estimated trend.  If the trend has moved up, it would allow for faster growth and higher wage increases without being inflationary.

 

 

Stocks OK Into Next FOMC Meeting, But Then?

The stock market should continue to climb this week, helped by corporate earnings and benign inflation data.  So far, more than 2/3 of Q423 earnings reports have exceeded estimates.  And, while not all of last week's US economic data slowed relative to their Q323 pace, many did and, importantly, inflation expectations fell.  All told, the door is not shut for Fed rate cuts at some point this year, and this expectations should underpin the market rally into next week's FOMC Meeting.  After the Meeting, the markets still will have to be concerned if economic growth or inflation are too strong.  The January Employment Report could be the next test.

The upshot of the latest round of US economic data shows a still resilient consumer and a modest upturn in residential construction but soft manufacturing outside of motor vehicles and high tech.  Overall, the labor market has resumed tightening, according to the Unemployment Claims data.  And, if the Claims data stay at their latest levels in this week's report, they would point to a speedup in January Nonfarm Payrolls (due February 2).  The Atlanta Fed model's latest Real GDP projection (2.4% q/q, saar) indicates that economic growth was slightly above trend in Q423.  

Real GDP Growth presumably needs to slow further this year if the Fed is to cut rates, unless inflation falls despite solid growth.  The Fed can be patient without shutting the door on cuts, which might be Fed Chair Powell's message next week.  One Fed official said he looks for rate cuts to begin in Q324.  Being patient means the Fed can downplay high prints for January inflation data, saying they reflect start-of-year hikes that won't persist.  For example, pharmaceutical companies are reported to be hiking a number of drug prices this month, which could show up in the CPI.  This week's inflation data -- the PCE Deflator -- are for December.  Consensus looks for a benign 0.2% m/m for both Total and Core.  This would be lower than the CPI's 0.3% prints and be in line with the Fed's 2% target.

Even with a patient Fed, the markets will likely respond negatively if upcoming data don't point to slower, non-inflationary growth.  With the Fed on hold, work to slow the economy will fall on the markets.  So, they may not be happy with a strong January Employment Report, particularly if it shows a persistently large increase in Average Hourly Earnings.  

 

 

Corporate Earnings and The US Economy Now The Focus

The stock market may trade cautiously but with an upside tilt this week, as the Q423 corporate earnings season begins.  Consensus looks for a slowdown in earnings, but the expectation may be too soft.  In addition, after the high December CPI, the market will be even more focused on the implication of  upcoming US economic data for Fed policy.  Without confirmation of low inflation, strong economic growth can't be dismissed.  Nevertheless, consensus expects mostly softer data this week, which could help stocks. 

Q423 Corporate Earnings

Consensus estimates about +1.0% y/y for Q423 corporate earnings, a slowdown from the 5.9% increase in Q323.  There is upside risk, as the macroeconomic backdrop is very similar to that of Q323.  Real Growth, oil prices and the dollar moved about the same on a y/y basis in both quarters and economic activity abroad improved slightly in Q423 (see table below).  However, there may have been further margin compression, as the Core CPI slowed by more than Average Hourly Earnings (AHE).  Indeed, it is the first quarter in a while when the Core CPI rose by less than AHE on a y/y basis.

                                                                                                                                         Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level) 

Q122            3.5                  63.4                +2.7                              5.4           6.4               57.8  

Q222            1.8                  60.9                +5.3                              5.3           6.0               53.9

Q322            1.9                  31.9                +9.0                              5.1           6.3               49.3

Q422            0.9                    6.7                +8.9                              4.9           6.0               47.1    

 

Q123            1.9                -19.5                 +3.0                              4.5           5.5               47.9 

Q223            2.4                -32.0                 +0.5                              4.4           5.2               44.7

Q323            2.9                -12.0                 -2.5                               4.3           4.4               43.2

Q423            2.8 *             -12.0                 -2.5                               4.1           3.9               43.8

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.2% (q/q, saar).

This Week's US Economic Data

Most consensus estimates suggest a slowdown from Q323 when Real GDP Growth was 4.9% (q/q, saar).  Retail Sales and Industrial Production are expected to be below their Q323 pace.  Manufacturing surveys are seen up m/m, but mixed relative to their Q323 averages.  Housing Starts are seen exceeding their's slightly.  The Unemployment Claims Data have a mixed message -- layoffs have edged down but re-hiring has worsened.  The latter is suggested by the increase in Continuing Claims.  Since the Claims data are the broadest of this week's data, the weakness in Continuing may have the biggest influence on Fed officials' outlook.  This week's Claims data, however, could continue to be distorted by faulty seasonal adjustment of the New Year holiday.  They risk rebounding after the prior week's decline, but they should be viewed with caution.

                                                            Consensus Estimate *        Q323 Average

NY Empire State Mfg Index                     - 5.0  level                      -5.3 level

Retail Sales                                                 0.3% m/m                      0.7% m/0

Retail Sales Ex Auto                                   0.2% m/m                      0.6% m/m   

Retail Inventories Ex Auto                                                                0.0% m/m     

Industrial Production                                  0.0% m/m                      0.3% m/m                                          

Mfg Output                                                        na                            0.2% m/m      

NAHB Housing Mkt Index                               37                               50 level   

Housing Starts                                            1.45 Mn Units                1.37 Mn Units

Housing Permits                                         1.48 Mn Units                1.48 Mn Units           

Phil Fed Mfg Index                                      -8.0 level                       -5.0 level      

Existing Home Sales                                 3.82 Mn Units                4.02 Mn Units

Initial Unemployment Claims                     207k level                     227k level

Continuing Claims                                       na                                1.695 Mn level

 * All data are for December, except for NY Empire State Mfg, NAHB Housing Market Index and Phil Fed Mfg Index.  They are for January.  Claims data are for latest week.

The December CPI

The 0.3% m/m December CPI (both Total and Core) was above the Fed's target.  However, the Report probably did not shut the door on Fed rate cuts this  year.  The excessive inflation was not widespread.  Owners' Equivalent Rent remains the main roadblock to achieving the Fed's 2% inflation goal.  All Items Less Shelter rose 0.2% m/m, and its y/y was 1.9%.  Core Less Shelter also rose 0.2% m/m, and its y/y was 2.2%.  At the post-FOMC news conference, Fed Chair Powell could express patience to see if OER slows in coming months.  Indeed, there was some suggestion in the Report that housing rent may be beginning to slow -- Primary Rent slowed to 0.4% m/m from 0.5%.  Or, he could take a more aggressive stand, arguing that economic growth has to weaken further to pull down inflation.  The high Average Hourly Earnings prints in November and December would support such a stand.

Door Still Open For Fed Rate Cuts

The stock market should move up this week, after it was dented last week by concern the economy won't be soft enough to persuade the Fed to cut rates this year.  The most important report, the December Employment Report, was indeed strong.  It showed the economy needing to slow further to satisfy the Fed.  But, it did not shut the door on Fed rate cuts in 2024, since it still hinted that a slowdown was in progress.  This week's US economic data could keep the door open and help stocks recover, as they are expected to show benign inflation.

Two of the Employment Report's components suggest a slowdown in progress:

1.  The decline in the Nonfarm Workweek to 34.3 hours from 34.4 pushed down Total Hours Worked (THW) to -0.2% m/m in December.  The December level of THW is flat relative to the Q423 average -- a soft take-off point for Q124.  Moreover, THW slowed to +0.8% (q/q, saar) in Q423 from +1.3% in Q323.

2.  The drops in Civilian Employment and Labor Force likely reflect the small sample bias of the Household Survey.  So, not much should be made of them, even though they more than unwound their November jumps.  However, they raise the possibility of a smaller increase in January Nonfarm Payrolls, as Civilian Employment has some leading relationship to Payrolls.

It's noteworthy that more than half of the +216k Payroll gain in December was in Health Care, Social Assistance and Government.  Excluding these sectors, Payrolls rose 105k in December, after being essentially flat in October and November (excluding the impact of strikers).  Net Returning Strikers added about 8k  to December Payrolls.  These sectors are presumably little affected by Fed tightening or a slowdown in economic growth.  Nevertheless, their job gains exert pressure on the labor market.  So, their job growth has to be offset by weakness in other sectors to achieve the Fed's desired increase in the Unemployment Rate to 4.0+%.   

December's  0.4% m/m increase in Average Hourly Earnings (AHE), the second in a row, shows that the labor market is too tight.  AHE rose at least 0.4% in a majority of sectors both for December and on average over the last three months.  AHE needs to rise by 0.3% or less to be consistent with the Fed's 2% price inflation target, taking account of productivity.

A factor that could reduce the need to slow the economy sharply is if inflation moves down toward the Fed's target of 2% for non-macroeconomic reasons.  Fed officials have cited the resolution of pandemic-related shortages and supply disruptions as one such reason.  Lower import prices stemming from the stronger dollar and economic weakness abroad are another.  A factor yet to be fully seen would be a slowdown in housing rent as the CPI survey catches up to the softening seen in private surveys. 

Consensus looks for +0.2% m/m in both Total and Core CPI for December.  This estimate looks reasonable even if housing rent does not slow from its recent trend of 0.5%, but it probably requires that the price declines seen in other CPI components in November continue in December.  This is conceivable.  The unwinding of pandemic-related problems and lower import prices could have underpinned November price declines.  And, they could have continued to exert downward pressure in the rest of the holiday season.  Although the y/y for Total CPI is expected to edge up, the y/y for the more important Core CPI is seen falling to 3.8% from 4.0%.