Corporate earnings and election uncertainty should continue to dominate the stock market this week. Although consensus looks for moderate prints for this week's key US economic data, uncertainty about the labor cost measures could dampen the market ahead of the prints. This week's key data will be the last Fed officials see before the November 6-7 FOMC Meeting. It is unlikely the data will deter a 25 BP rate cut, but they could influence the Fed's forward guidance at the meeting.
One of the election issues relates to Fed policy. Trump wants the President involved with FOMC rate decisions. This relates to Fed independence and, if he wins, would be a negative for the dollar (offsetting in part the positive impact from the threat of tariffs) and lift long-term yields, as the risk would be for political considerations to restrain rate hikes when needed to curb inflation.
Trump supporters say the Fed makes mistakes and thus needs to be changed. Ironically, one mistake they accuse the Fed of is representative of what Trump wants. They accuse the Fed of not tightening soon enough in 2021-22, which they say resulted in higher inflation. Although Fed Chair Powell attributes the delayed tightening to forecasts of a "transitory"pickup in prices, it would not be surprising if political considerations played a role. Powell did not want to act in a way that would run counter to Congress' legislative aim to boost the economy.
This is not to say the Fed never makes mistakes. The Fed did make mistakes in 2007-08, which exacerbated if not triggered the Great Recession. They made 3 major mistakes: /1/ They analyzed the problem as an illiquidity issue at banks that required interest rate cuts. Instead, the problem really was a lack of confidence among banks regarding the extent of subprime mortgage risk in their balance sheets. A guarantee of bank liabilities for say 5 years by Treasury or the Fed to let them unwind their subprime positions likely would have solved the problem, similar to how the ECB tackled a bank confidence problem in 2011. Lowering interest rates in 2007-08 boosted commodity prices, particularly oil, which hurt the consumer. /2/ Fed Chair Bernanke and Treasury Secretary Paulson went on TV to say the US economy was heading into a big recession. This destroyed business confidence, leading to massive layoffs. /3/ The Fed did not save Lehman Brothers, punishing the company for its mistakes rather than acting to bolster market confidence (again not understanding the confidence problem). By the way, this is not the conventional explanation for the Great Recession.
The Fed gets into perception trouble with its Central Tendency forecasts, which are often wrong. In a sense, the forecasts are bound to fail because markets will move in a way to prevent them from happening. For example, longer-term Treasury yields could fall if the Fed presents a weak economic forecast. Lower yields would lift stocks, boosting consumption as well as housing demand. A better approach could be to publish targets for GDP Growth, Unemployment Rate and Inflation rather than forecasts. Then, the Fed could be held accountable without seeming clueless about the outlook.
Regarding this week's key US economic data:
Consensus looks for a benign October Employment Report. Payrolls are seen slowing sharply to +140k m/m from +254k in September, while the Unemployment is seen steady at 4.1%. Average Hourly Earnings (AHE) are expected to slow to the 0.3% m/m trend, after climbing 0.4-0.5% in the prior two months. Unemployment Claims data support the idea of slower job growth in October. In addition, there were 41k additional strikers (including Boeing workers) that will subtract from Payrolls but should be added back to get a clearer picture of the underlying demand for labor. A 180k Payrolls gain would be somewhat high from the Fed's perspective and be consistent with a lower Unemployment Rate. Strikers, themselves, do not affect the calculation of the Unemployment Rate, as they are not counted as unemployed. There is no evidence regarding AHE -- unfortunate since this may be the most important part of the Report.
Regarding labor costs, consensus looks for the Q324 Employment Cost Index to rise 0.9% (q/q), the same as in Q224. Even though high from a pre-pandemic perspective, a steady pace would be tolerable. Evidence from AHE is mixed. AHE sped up in Q324 after slowing in Q224. In the past 6 quarters, ECI and AHE sped up or slowed together half the time. The other half the speedup or slowdown in ECI matched that of AHE in the prior quarter, which suggests a slowdown in the Q324 ECI.
(q/q percent change)
AHE ECI
Q324 1.06 na
Q224 0.87 0.9
Q124 1.02 1.2
Q423 0.97 1.0
Q323 0.92 1.0
Q223 1.2 1.0
Q123 1.1 1.2
Q422 1.2 1.1
Q322 1.1 1.2
Consensus looks for 3.0% (q/q, saar) Q324 Real GDP, in line with the Atlanta Fed Model estimate of 3.3%. A sub-3.0% print cannot be ruled out. Consensus also looks for the October Core PCE Deflator to rise 0.2% m/m, smaller than the 0.3% increase in the Core CPI and better in line with the Fed's 2% inflation target. A consensus print for the Core Deflator should be a market positive.
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