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.
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