Fed Policy Intentions Helping Stocks

The stock market is likely to continue to grind higher this week, buoyed by the Fed's intention to cut the funds rate further even with above-trend economic growth in Q324.  Indeed, the Atlanta Fed model raised its estimate of Q324 Real GDP Growth to 3.4% from 3.2% (qq, saar) after the strong September Retail Sales report more than offset the implications of the soft Industrial Production and Housing Starts reports. However, the risk of higher wage inflation could become an issue ahead.

The strength of Q324 Real GDP does not appear to have stopped the Fed from planning to cut the funds rate further, albeit at a smaller 25 BP pace from the initial 50 BP cut.  To be sure, the model's estimate may be too high.  Other data show softening in manufacturing output (mostly outside of high tech), housing starts, and Total Hours Worked.  (The official report on Q324 GDP will be released October 30.)  Even if the model's estimate is correct, the Fed's intention appears to be to bring the funds rate down to its longer-term neutral level in order to sustain solid, non-inflationary economic growth -- as long as inflation remains near its 2% target.  The Fed presumably would stop easing if if looks as if the trend in inflation has turned up.

This presumed requirement suggests that the most important part of the October Employment Report could be Average Hourly Earnings (AHE).  It would be problematic if AHE does not fall back to its 0.3% m/m trend after rising 0.4-0.5% in August and September.  Away from the Report, the recent outsized wage gains in the Boeing and Longshoremen contracts are a concern, particularly if it influences other wage demands.  The Payrolls part of the Report should be comforting for the Fed, as the Unemployment Claims data suggest (at this point) a smaller increase than the large +254k gain in September.   The Report is due on November 1.

Fed officials, including Chair Powell, insist that their policy path is data dependent.  Powell says the way to think of data dependency is in terms of the impact on the Fed's outlook.  This approach has two problems, one from the perspective of  the markets and the other from the perspective of the Fed.  The markets' problem is that the impact on the Fed's outlook is not clear.  At the extreme, the Fed's rate decisions could seem arbitrary, with little if any relationship to the data.  The Fed's problem is that its ability to forecast accurately is not particularly good.  Officials could incorrectly dismiss a strong report as one-off, for example -- thus sticking with easing instead of holding back.  They will know whether the dismissal was correct from seeing future data releases, although the more immediate reaction of the longer-end of the Treasury market can offer a hint.  For example, a sell-off in the longer end on a Fed move would hint that the Fed overdid its policy move.