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.
