The stock market will be entering the seasonally weak month of August amidst uncertainty about the next Fed move. Fed Chair Powell said the Fed is in "wait and see" mode until the September 16-17 FOMC Meeting, waiting to see if upcoming data lean toward economic weakness or higher inflation.
Powell said that monetary policy is balancing the risks attached to its two mandated targets -- Unemployment and Inflation, not GDP Growth. So, the most important real-side data for the Fed will relate to the labor market -- particularly the Unemployment Rate. On the inflation side, the Fed likely wants to see if tariffs boost prices just once and for all or trigger a cascading lift-off in prices.
It is not clear that upcoming data will provide a clear enough picture for the Fed to change policy by the time of the September FOMC Meeting. And, Powell may keep the balance of risks argument to keep policy steady then. Arguably, the Fed is relying on a balance of risk reasoning to cover for its real concern about the politically sensitive inflationary consequences of the tariffs. This concern would suggest a longer waiting period than just the time to the September FOMC Meeting.
In any case, the July Employment Report may not have been weak enough to move the Fed toward an easing. Although job growth remained below trend, the 4.2% Unemployment Rate stayed in its recent range and Total Hours Worked pointed to continued GDP Growth in Q325. (Indeed, the Atlanta Fed Model's early forecast is 2.1% (q/q, saar) for Q325 Real GDP.) Wage inflation was steady.
Fed Chair Powell admitted that the US economy had slowed over H125. However, he emphasized that despite the slowdown, the labor market remained solid -- evidenced by the still low Unemployment Rate. To be sure, there could be a delay before slow GDP Growth results in an increase in the Unemployment Rate. So, Powell risks being late in adjusting his view of the policy risks by downplaying GDP Growth.
Nevertheless, steady Fed policy now may be appropriate because the underlying trend in GDP growth may have slowed. So, what looks like weak growth, in fact, may be neutral. From the stock market perspective, a slower trend in economic growth is bad for corporate earnings (a negative) but helps hold down longer-term yields (a positive).
The underlying trend in GDP Growth may have ratcheted down because Population slowed sharply, to 0.5% (annualized) over H125 from 0.8% over 2024 -- presumably because of the drop-off in immigration. In terms of GDP, the slowdown in Population would need to be offset by increases in Labor Force Participation (share of population employed or unemployed and looking for a job) or a speedup in Productivity Growth to keep the trend in GDP Growth where it's been.
A caveat: Labor Force Participation may be related to the strength of demand for labor. When people see companies looking for workers, they may decide to enter or re-enter the labor force. An increase in Participation would temporarily allow for a stronger-than-underlying pace of GDP Growth without sparking inflation. Keeping monetary policy unchanged may not give this Participation response a chance to happen.
Powell also may be too accepting of the 4.2% Unemployment Rate. While the Unemployment Rate is historically low, it may be close to a level that could be viewed as dis-inflationary. This is because wage inflation has been fairly steady. Average Hourly Earnings rose 0.3% m/m on average in 3 of the past 4 quarters as well as in July. The Employment Cost Index was steady at 3.6% y/y in Q225 but in a slight downtrend excluding incentive pay. Compensation/Hour -- the broadest measure of labor costs -- will be released next week for Q225. Nevertheless, a dis-inflationary level of the Unemployment Rate would be desirable if tariffs have more than a one-time impact on prices and would not argue for an easing in monetary policy. Perhaps that is why Powell is satisfied with the level.
