A Positive Holiday Week?

The stock market has a couple of potential positives going for it this week -- an historical tendency to climb during the Thanksgiving Week and a possible below-consensus print for the Fed's favorite measure of inflation.  

The S&P 500 has tended to rise in the Thanksgiving Week, particularly on the day before and after the holiday.  This year, the most important US economic data for the week -- the October PCE Deflator -- will be released the day before, November 27.  Consensus agrees with Fed Chair Powell's seeming forecast of 0.2% m/m Total and 0.3% Core (see last week's blog).   However, there is a possibility of a lower print as a result of the different weightings in the PCE Deflator from those in the CPI.  In particular, Used Car Prices -- which jumped 2.7% in the CPI -- gets much less weight in the PCE Deflator.  Meanwhile, Apparel Prices -- which dropped 1.6% in the CPI -- gets greater weight in the Deflator.  To be sure, there are other differences between the CPI and PCE Deflator, as well.  So, a below-consensus print is not certain.

Unemployment Claims are sending mixed signals about the labor market.  Initial Claims are making new lows for the move down, indicating a decline in layoffs.  Continuing Claims, however, have moved up, suggesting some softening in hiring.  Although early, at this point, the Claims data suggest that November Payrolls could be on the soft side once the rebounds from bad weather and strikes (about 100k) are taken out.  Note that the best way to evaluate November Payrolls will be to average the m/m change with October's.  The November Employment Report is due December 6.

The combination of benign inflation and soft underlying job growth could keep open the door for a Fed rate cut at the December FOMC Meeting.  However, Powell's more cautious comments and the uncertainties of fiscal policy under the new Administration next year argue against one.

Regarding fiscal policy, the termination of Trump's Attorney General nominee, Gaetz, may have potentially positive implications for stocks.  Trump's acquiescence of the shift to another candidate raises the possibility that he will compromise on other policy decisions when faced with strong opposition.  As a result, some of his extreme election promises may not be as likely as feared, particularly those that would be harmful to the economy.

 

 

Fed Policy Shift?

The stock market may remain under pressure this week, as prospects of a Fed rate cut in December fade amidst typical year-end tax-related selling.  However, keeping rates steady is not necessarily bad for stocks, although it shifts the counter-cyclical burden to the markets.

Fed Chair Powell and other Fed officials continue to hint that rates will be held steady at the December  17-18 FOMC meeting.  Powell said "the economy is not sending any signals that we need to be in a hurry to lower rates."  He appears to be finally acknowledging that the economy's recent strength is sustainable, suggesting that the Fed's Central Tendency update at the meeting will show stronger GDP Growth as well as a higher funds rate for next year than in the September Central Tendency forecasts.  

Steady rate Fed policy may not be entirely bad for stocks.  It would preserve room for the rate to be cut when the economy in fact needs it.  This potential to ease represents an insurance policy for stocks regarding the economic outlook, which is a market positive.  

The markets, however, will play a greater role in determining whether financial conditions should be tighter to fight inflation or easier to fight the risk of recession.  The long end of the Treasury market will sell off if inflation and/or the economy look to be speeding up or it will rally if inflation/economic growth appear to be slowing.  The long end's actions could determine the path of the stock market, with stocks moving inversely with the long-end yields.  Handing over counter-cyclical policy to the markets may be the best approach for the Fed in the face of uncertain fiscal policy in 2025.  The markets will move more rapidly in response to events than would Fed monetary policy and be immune to political flak.

Between now and the December FOMC Meeting real-side economic data risk speeding up as they rebound from bad weather and strikes.  The markets may not react sharply to this strength,  however, discounting it as temporary.   What may be more important will be data on wages and prices, as measured by Average Hourly Earnings (AHE) and the CPI.  A slowdown would be a relief for long-term Treasuries and stocks, while a still-high pace could spark a sell-off.  There is no reliable evidence for November AHE.  There is a possibility that the November CPI could move down to 0.2% if the handful of components with large changes in October flatten out and Owners' Equivalent Rent returns to 0.3% from 0.4% in October.

Powell still does not acknowledge an inflation problem.  He downplayed the high October Core CPI and Core PPI, translating them into sub-3.0% y/y increases in the Total and Core PCE Deflators.  Citing y/y increases, however, is disingenuous since they are dominated by past inflation prints.  His figures imply 0.2% m/m for Total and 0.3% for the October Core PCE Deflator, the same as in the CPI.  These would not be good prints, as the Core would be elevated for the second month in a row.  To be sure,  perhaps he just applied the CPI m/m increases to the PCE Deflator, although his figures appeared to be presented as forecasts.  Smaller increases can't be ruled out because components are weighted differently in the PCE Deflator than in the CPI.  The PCE Deflator will be released November 27.

 

  

     

 

"Trumponomics" and the Fed

The stock market rally should continue this week, with possible help from a below-consensus October CPI.  Prospects of a pro-growth Trump economic policy should underpin the market's strength.  However, the policy could create problems down the road, as it generates inflationary pressures.  Indeed, labor cost inflation remains an issue, even though it has not gotten much, if any, mention in the press or by the Fed.

 "Trumponomics" will be an extension of Bidenomics in one way.  It will try to redirect the US economy to being more insular, using tariffs as one tool.  The goal in both overall polices is to bring manufacturing from abroad to the US.  This includes the operations of non-US as well as US companies.  In contrast to Bidenomics, Trumponomics presumably will not direct  investments to particular sectors, e.g., alternative energy EVs.  Instead, it will include tax cuts, deregulation, and presumably increased defense spending (also part of Bidenomics).  In both cases, the associated stimulus help propel US economic growth. 

The problem with both approaches is that the associated stimulus needs to crowd out other domestic spending if inflation is not to speed up, particularly when the economy is operating near full employment as it is now.  Higher inflation is one way the markets crowd out spending.  In the Biden case, the large influx of immigrants -- legal and non-legal -- mitigated the need for crowding out as it boosted the labor force.  This cushion may not exist under Trump, given his threat to stop or reverse the immigration.  As a result, inflation risks could be higher under Trump. 

To be sure, labor cost inflation remains high, even with the influx of immigrants.  Compensation/Hour -- the broadest measure of labor costs -- has sped up on a y/y basis for the second year in a row:  5.5% in Q324 versus 4.8% in Q423 and 2.4% in Q422.  Productivity Growth has been a partial offset, up 2.0% or more (q/q, saar) in each of the past four quarters.  Unit Labor Costs were up 3.4% (y/y) in Q324, versus 2.1% in Q423.  ULC rose 1.9% (q/q, saar) in Q324 (above the 0.5% consensus as was the risk), but they have tended to slow in the second half of the year so they could be understating trend.  They need to stay around 2.0% both on a q/q and y/y basis to be consistent with the Fed's inflation target.

Labor cost inflation along with increased stimulus could lead to a reversal of the Fed's policy easing at some point.  Higher longer-term yields will likely lead the Fed in efforts to restrain demand.  At this point, however, the Fed appears to be steadfast in its policy to lower the funds rate to what it views as a neutral level with regard to the economy.  In his post-FOMC news conference, Fed Chair Powell said that while the Fed is not on a preset course of easing policy, the current policy stance is in a very good place and that the Fed is trying to stay on an easing path that is neither too fast or too slow.  He said the Fed would slow the pace of easing if the rate is closing in on a reasonable estimate of a neutral level.  Fed officials are beginning to think of this possibility, but their baseline forecast is to continue to ease into next year.

Fed Chair Powell made several comments, nonetheless, that raise the possibility of a pause in rate cuts.  He acknowledged that the latest data have reduced the downside risks to the economy.  Some business leaders, he said, think the economy will be better in 2025 than in 2024.  He also acknowledged that wage inflation is currently above the pace consistent with 2% price inflation -- unless productivity remains strong.  However, he said the Fed does not see wages as a significant source of inflationary pressures now.  

Powell blamed housing rent for keeping price inflation above target.  Re-negotiated rent on long-term leases are seen as catching up to more recent rent hikes and that this catch-up will end at some point, suggesting the rent component of the CPI will slow eventually.  There was hope for the latter in the September CPI, where Primary and Owners' Equivalent Rent (OER) slowed to 0.3% m/m from a 0.4% trend.  A repeat 0.3% OER in this week's October CPI Report increases the risk of a below-consensus print.  Consensus looks for +0.2% m/m Total and +0.3% Core.  Moderation in airfares and apparel, both of which jumped in September, are likely needed for a below-consensus print, as well.

Powell made one comment at the news conference that allays concern about Trump's threat to become personally involved in monetary policy decisions.  Powell said he would not resign nor give up the chair of the Fed Board if ordered to do so by Trump.  Apparently, the law prevents Trump from firing or demoting him.  Powell's determination to stay would sustain the independence of the Fed, which is a positive for all the financial markets.

 

Elections and FOMC Meeting This Week

The markets will finally see the results of the US Elections and the November 6-7 FOMC Meeting this week.  They could trade cautiously into these events.  What may be most important for the markets is whether the Presidential Election is resolved without a problem or if neither party dominates all branches of government.  The stock market could have a relief rally in either case.

To be sure, the market impact (stocks, Treasuries and dollar) of the Presidential Election could depend on who wins. But both candidates have policy proposals that are problematic for the economy and markets.  The potential implementation of these proposals could restrain a positive market impact.  Questions will remain whether the proposals will be put into effect, either legislatively or by executive order. 

Some market commentary has attributed the recent sell-off in the long end of the Treasury market to the potential for a blowout Federal Deficit, particularly if Trump is elected.  This explanation, however, may not be entirely right.  If fears of a sharply higher Deficit (and the presumed inflationary result) were the reason, the dollar should have fallen in the FX market, as well.  This did not happen.  Instead, the dollar has strengthened.  An explanation for the combination of higher long-term yields and stronger dollar could be an increasing concern about Trump's proposed tariffs.  The latter would boost the dollar on the expectation of a smaller trade deficit.  The tariffs also would boost inflation initially and thus the long end of the Treasury market through higher inflation expectations.  (Note, that the direct impact of the tariffs on prices should unwind over time as the dollar strengthens.)   If Harris wins, these market moves could unwind --  which would be a positive for the stock market.

The Fed is likely to cut the funds rate by 25 BPs at this week's FOMC Meeting.  And, while Powell should keep open the door for further rate cuts, he may be more cautious about their timing.   The economy appears to be growing moderately, but wage increases may be somewhat problematic.  Total Hours Worked in October are above the Q324 average, despite being held down by bad weather and strikes in the month.  They suggest another quarter of good-sized GDP growth, particularly taking account of a post-hurricane/post-strike bounce-back in economic activity.  The renewed downtrend in Initial Unemployment Claims in the past two weeks also suggests economic growth is fine.  The Atlanta Fed model's early estimate of Q424 Real GDP Growth is 2.3% (q/q, saar).

On the wage front, Average Hourly Earnings (AHE)  rose an above-trend 0.4% m/m in October, the second high print in the past three months.  The y/y rose to 4.0% from 3.9% in September.  The broader Employment Cost Index, in contrast, had better news.  It slowed to 0.8% q/q in Q324 from 0.9% in Q224.  The slowdown fits with the Fed's expectation of a gradual deceleration in inflation.  The ECI averaged 0.6-0.7% before the pandemic.

This week's report on Q324 Productivity/Compensation/Unit Labor Costs, however, risks adding to the labor cost problem.  Consensus looks for Compensation/Hour -- the broadest measure of labor costs -- to rise by only 2.8%, which would be a good number.  But, the risk is for a larger increase.  To be sure, speedier wages would not be inflationary if offset by higher productivity growth.  And, productivity in Q324 stands to be strong.  Consensus looks for 2.3% (q/q, saar) Productivity -- in line with the strong 2.4% average since Q123.  And, the risk is for a higher print.  But, the balance of risks between Compensation and Productivity weighs toward a higher print for Unit Labor Costs (ULC) than the consensus estimate of 0.5%.   The recent trend in ULC has been down, with the y/y hitting a slight 0.3% in Q224, well below the 1.7% y/y increase in Q423.  Anything below 2.0% suggests slower price inflation ahead.