The stock market may trade cautiously ahead of the February 1 deadline regarding 25% tariffs on Mexico and Canada. Trump could go through with them (a market negative) or hold back and announce negotiations (a market positive). The market should take this week's FOMC Meeting in stride. Although the Fed will not cut rates, it will likely keep open the door for cuts later this year if needed. Corporate earnings as well as this week's key US economic data will likely be market positives.
Trump's threat to impose 25% tariffs on imports from Columbia is minor compared to such a tariff on Mexico and Canada. US imports from Columbia were about $18 Bn last year, versus about $900 Bn from Mexico and Canada combined.
There are two reasons to expect the Fed to keep monetary policy steady at this meeting. /1/ The macroeconomic background does not call for lower rates. GDP Growth is strong and the labor market solid. Underlying inflation is on the desired downward path, but the pace is still too high. /2/ Trump's insistence that rates should be cut almost guarantees the Fed will not do so. Fed officials need to show their independence, which they view as paramount. Moreover, if they cut rates, inflationary implications of the implicit loss of independence would boost longer-term yields and weaken the dollar.
In his post-Meeting news conference, Fed Chair Powell, nevertheless, will likely keep open the door for rate cuts later this year, since this possibility is part of the projections made at the December FOMC Meeting. However, he may indicate that policy easing will happen only if warranted by economic conditions. The trend in economic growth would have to weaken and inflation continue to slow. (Note that the extremely cold weather in parts of the country could hurt economic activity temporarily.) This policy stance should be positive for the stock market. Continuing solid economic growth is good for profits, so a steady Fed is not a problem. Moreover, having a ready-to-ease-if-needed Fed in the background puts a floor on downside risks in the economic outlook.
Powell is likely to downplay any suggestion of policy tightening that may arise among the questions raised by reporters. He could say this possibility was not discussed at the meeting and is not part of the officials' projections made in December. Although economic growth appears to be continuing at a faster pace than expected by the Fed, officials will likely tolerate it for two reasons. /1/ Strong productivity growth has been an important factor behind recent GDP growth. To that extent, the growth should not be inflationary. /2/ Labor cost inflation remains in check, particularly according to the broadest measure, Compensation/Hour.
Powell will not likely comment on Trump's policy proposals, such as clamping down on immigration and extending tax cuts, citing uncertainty surrounding them -- uncertainty regarding whether or to what extent they will happen and also what their effects might be.
This week's key US economic data are expected to be market-friendly both for stocks and Treasuries. The first release of Q424 Real GDP Growth is seen by consensus at a robust 2.7% (q/q, saar), close to the Atlanta Fed Model's forecast of 3.0%. Consensus also sees a benign 0.2% m/m increase for the December Core PCE Deflator. Although the modest December CPI suggests downside risk to the PCE Deflator, the large increase in PPI Airfares will feed into the PCE Deflator and stands as an offset. The y/y for Core should be steady at 2.8%, but an uptick to 2.9% can't be ruled out. Consensus expects the Q424 Employment Cost Index (ECI) to slow to 1.0% (q/q) from 1.1% in Q324. Average Hourly Earnings (AHE) supports the idea of a slowdown in the ECI, as speedups/slowdowns in the AHE were matched by the ECI a quarter ahead in 5 of the past 6 quarters (see table below).
(q/q percent change)
AHE ECI
Q423 1.0 na
Q223 1.2 1.0
Q123 0.8 1.2
Q422 1.2 1.1
Q322 1.1 1.2
Q22 1.1 1.3
Q122 1.3 1.4
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