The stock market may be buoyed this week by expectations of a Fed rate cut, as the August Employment Report is expected to be soft. A consensus-like Report would likely pave the way for a Fed rate cut at the September 16-17 FOMC Meeting. Also, the Appeals Court ruling against most of Trump's tariffs could mollify some of the markets' and Fed's concern about the inflation outlook.
Consensus looks for a sub-trend +78k m/m increase in August Nonfarm Payrolls, slightly more than the +73k in July, Both are lower than the +115k that would keep the Unemployment Rate steady, assuming no change in the Labor Force Participation Rate. Moreover, the Unemployment Claims data tilt toward an even smaller Payroll increase in August than in July. Consensus looks for the Unemployment Rate to tick up to 4.3% from 4.2%, which is a reasonable expectation based on the Claims data and the rounding analysis discussed in last week's blog. Consensus also expects Average Hourly Earnings to climb a trend 0.3% m/m, the same pace as in July. A trend increase would argue against a wage-price spiral being triggered by tariffs. The consensus estimate of a steady 34.3 Hour Nonfarm Workweek would allow for an increase in Total Hours Worked in August and Q325, suggesting that economic growth is continuing.
Other key data this week should support the idea of modest economic growth, according to consensus estimates. The Mfg ISM is expected to edge up to 48.6 in August from 48.0 in July. Both are associated with Real GDP Growth of 1.5-2.0%. The Services ISM is seen up a bit, as well, to 50.5 from 50.1.
In contrast to the expectation of modest job and economic data, this week, the Atlanta Fed Model's estimate of Q325 Real GDP Growth was strong, revised up to 3.5% from 2.2% (q/q, saar), thanks mostly to a shift from a subtraction to an add by Net Exports. However, this shift looks questionable given the wider Trade Deficit in July. The latter was caused mostly by a rebound in imports of industrial supplies, which could have been due to higher prices as the model apparently assumed. Nevertheless, the 3.5% GDP estimate should be viewed with caution. The Model's estimate is still early, and softer data for August and September would pull it down. So, at this point, the Model's estimate of strong Q325 Real GDP Growth should not stand in the way of a Fed rate cut as long as the August Employment Report is soft.
As for inflation, the July PCE Deflator was benign and should not be an impediment to a rate cut, particularly considering tariffs had some impact that could be temporary. The Core PCE Deflator rounded up to 0.3% from 0.27%. And, the Market-Based Core PCE Deflator rose only 0.2%.
The Appeals Court's ruling against most of Trump's tariffs needs to be affirmed by the Supreme Court to significantly reduce the markets' and Fed's concern about their inflationary impact. Even without the termination of the tariffs, Trump's policies and actions have mixed implications for inflation.
/1/ Tariffs will almost certainly boost prices -- putting aside the possibility that the Supreme Court will affirm the negative ruling of the Appeals Court -- as will Trump's weak dollar preference. However, there are caveats that could dampen their impact on prices. If companies are slow to pass through the higher costs of imports, the price level will eventually fully reflect them but the boost to inflation -- the rate of change of prices -- will be modest and extend for a longer time than if the tariffs were fully passed through immediately. In other words, US purchasing power will be reduced slowly. The other caveat is that foreign companies could lower their prices to maintain market share in the US. In this case, there would be no increase in inflation.
/2/ If Trump's appointees force the Fed to lower the funds rate and keep it low, the risk is the policy will overly stimulate the economy as well as depress the dollar in the FX market, Both would lead to higher inflation. There are two caveats: /a/ The policy could backfire: longer-term yields could rise in response to the inflationary threat, thereby pulling down stocks. Both developments would hurt economic growth. /b/ The easy monetary policy would not be inflationary if the economy is in the process of slowing sharply or falling into recession.
/3/ If Trump damages the independence of the Fed, inflationary concerns will likely boost longer-term yields and depress the dollar. In the short run, the former would hurt economic activity while the latter would lift inflation.
/4/ Deporting illegal immigrants reduces the labor force, thereby tightening the labor market and putting upward pressure on wage rates.
The yield curve would signal whether a Trump-forced monetary policy change would likely boost inflation or not. A steeper curve, with longer-term yields having risen, would signal an inflationary implication and, ironically, hurt interest-sensitive spending such as housing -- the sector Trump thinks his easy monetary policy would help.
Some of Trump's actions have reduced prices. He put pressure on the Saudis to keep oil prices down. And, the drop-off in foreign tourism to the US in reaction to his tariffs may have held down hotel rates. He also is putting pressure on pharmaceutical companies to lower prescription drug prices. All these efforts have the undesirable effect of reducing incentives for domestic production and innovation, but they do help hold down inflation.
Trump's actions are not the only government policies that boosted inflation. Some of the higher prices hurting the consumer may have been triggered by the hikes in the minimum wage during the past few years. These hikes probably played a role in the surge of restaurant prices, for example.
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